10-K 1 cxdc_10k-123111.htm FORM 10-K FOR THE YEAR ENDED 12/31/2011 cxdc_10k-123111.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
T
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2011
 
or
 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______________ to _____________
 
Commission File No. 001-34546
 
CHINA XD PLASTICS COMPANY LIMITED
(Exact name of registrant as specified in its charter)

Nevada
 
04-3836208
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
No. 9 Dalian North Road, Haping Road Centralized Industrial Park,
 Harbin Development Zone,
Heilongjiang Province, P. R. China
 
150060
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code: (86) 451-8434-6600
 
Securities registered pursuant to Section 12(b) of the Act:
 

Title of each class
 
Name of each exchange on which registered
Common Stock, $0.0001
 
NASDAQ Global Market
 
Securities registered pursuant to Section 12(g) of the Act:  None
 
Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes £  No T
 
Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes £   No T
 
Indicate by checkmark 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   T     No  £
 
 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes T    No   £
 
 
 
 

 
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   £
 
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer   £
Accelerated filer  £
   
Non-accelerated filer    £
(Do not check if a smaller reporting company)
Smaller reporting company   T
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes £  No T
 
The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2011 was approximately $63,398,613.
 
As of March 20, 2012, there were 47,527,367 shares of the issuer’s common stock outstanding.
 
Documents incorporated by reference: None.
 

 
 

 

 
CHINA XD PLASTICS COMPANY LIMITED
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011
 
 
Table of Contents
 
   
PART I 
    1
 
Item 1
Business
  1
 
Item 1A
Risk Factors
  22
 
Item 1B
Unresolved Staff Comments
  34
 
Item 2
Properties
  34
 
Item 3
Legal Proceedings
  35
 
Item 4
Mine Safety Disclosures
  35
   
PART II
    36
 
Item 5
Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
  36
 
Item 6
Selected Financial Data
  37
 
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  38
 
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
  49
 
Item 8
Financial Statements and Supplementary Data
  50
 
Item 9
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
  50
 
Item 9A
Controls and Procedures
  50
 
Item 9B
Other Information
  51
   
PART III
    52
 
Item 10
Directors, Executive Officers and Corporate Governance
  52
 
Item 11
Executive Compensation
  61
 
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  70
 
Item 13
Certain Relationships and Related Transactions and Director Independence
  71
 
Item 14
Principal Accountant Fees and Services
  73
   
PART IV
    74
 
Item 15
Exhibits, Financial Statement Schedules
  74
 
Financial Statements
 
Index to Consolidated Financial Statements
  F-1
Reports of Independent Registered Public Accounting Firms
  F-2
Consolidated Balance Sheets
  F-4
Consolidated Statements of Comprehensive Income
  F-5
Consolidated Statements of Changes in Equity
  F-6
Consolidated Statements of Cash Flows
  F-7
Notes to Consolidated Financial Statements
  F-9

 
i
 
 

 
 
PART I
 
ITEM 1.   BUSINESS.
 
Our Business
 
China XD Plastics Company Limited (“China XD”, “we”, and the “Company”, and “us” or “our” shall be interpreted accordingly) is one of leading specialty chemical companies engaged in the research, development, manufacture and sale of modified plastics primarily for automotive applications in China. Through our wholly-owned subsidiary Harbin Xinda Macromolecule Material Co., Ltd. (“Harbin Xinda”), we manufacture and sell modified plastics, primarily for use in the fabrication of automobile parts and components. We develop our products using our proprietary technology through our wholly-owned research laboratory, Harbin Xinda Macromolecule Material Research Center Co., Ltd. (“Xinda Macromolecule Research Center”). Xinda Macromolecule Research Center, is a professional macromolecular material research and development institution and has received 211 certifications from manufacturers in the automobile industry as of December 31, 2011. We are the only Company certified as a National Enterprise Technology Center in modified plastics industry in Heilongjiang Province.  Our Research and Development (“R&D”) team consists of 94 professionals and 11 consultants, including two consultants who are members of Chinese Academy of Engineering, and one consultant who is the former chief scientist of Specialty Plastics Engineering Institute of Jilin University. As a result of the combination of our academic and technological expertise, we have a portfolio of 26 patents, two of which we have obtained the patent rights and the remaining 24 of which we have applications pending in China as of December 31, 2011.  
 
Modified plastic is produced by changing the physical and/or chemical characteristics of ordinary resin materials. In order for plastics to be used to produce automobile parts and components, they must satisfy certain physical criteria in terms of mechanical functionality, stability under light and heat, durability, flame resistance, and environmental friendliness. Our unique proprietary formulas and processing techniques enable us to produce low-cost high-quality modified plastic materials, which have been certified by many of the major domestic and international automobile manufacturers in China. In addition, we also provide specially engineered plastics and environment-friendly plastics for use in oilfield equipment, mining equipment, vessel propulsion systems and power station equipments.
 
China XD’s primary end-market is the Chinese automotive industry that has been rapidly growing for the past few years where our modified plastics are used by our customers to fabricate the following auto components: exteriors (automobile bumpers, rearview and sideview mirrors, license plate parts), interiors (door panels, dashboard, steering wheel, glove compartment and safety belt components), and functional components (air conditioner casing, heating and ventilation casing, engine covers, and air ducts). Our specialized plastics are utilized in more than 23 automobile brands manufactured in China, including leading brands such as AUDI, BMW, Toyota, Buick, Mazda, Volkswagen, Cherry, Geely, and Hafei new energy vehicles. As of December 31, 2011, 211 of Harbin Xinda’s automotive-specific modified plastic products have been certified by one or more of the automobile manufacturers in China and are in commercial production. As of December 31, 2011, 75 of our products had been in the process of product certification by automobile manufacturers.
 
We operate three manufacturing bases in Harbin, Heilongjiang in the People’s Republic of China (“PRC”). As of December 31, 2011, we had approximately 165,000 metric tons of annual production capacity across 38 automatic production lines utilizing German twin-screw extruding systems, automatic weighing systems and Taiwan conveyer systems. In December 2011, we successfully launched our third production base in Harbin which has 90,000 metric tons of annual production capacity across 20 new production lines installed in two completed factories. In addition, there are three additional factories which are currently in construction in our third production base and expected to be completed in the second half of 2012 and which could support our production capacity expansion beyond 2012.
 
1
 
 

 
 
Our History
 
China XD, formerly known as NB Payphones Ltd. and NB Telecom, Inc., was originally incorporated under the laws of the state of Pennsylvania on November 16, 1999. On December 27, 2005, we migrated to the state of Nevada.
 
On December 24, 2008, we acquired Favor Sea Limited (“Favor Sea BVI”), a British Virgin Islands corporation, which is the holding company for Harbin Xinda and Harbin Xinda’s wholly-owned subsidiary, Harbin Xinda Macromolecule Material Research Institute (“Research Institute”). Harbin Xinda is a high-tech manufacturer and developer of modified plastics, which was established in September 2004 under the laws of the PRC. In December 2010, our management determined that the Research Institute could not meet the Company’s development needs, including meeting the criteria to be a National Enterprise Technology Center. As a result, the Research Institute was deregistered.
 
On June 11, 2010, Harbin Xinda established Harbin Xinda Macromolecule Material Engineering Center Co., Ltd. (“Xinda Engineering Center”) to focus on research and development of high-end products such as engineering plastics, modified PA, alloy plastics and modified ABS.
 
On October 14, 2010, Harbin Xinda established Heilongjiang Xinda Software Development Company Limited (“Xinda Software”) to develop software applications that provide certain standard and programmable technical services remotely.
 
On December 10, 2010, Harbin Xinda established Xinda Macromolecule Research Center to focus on research and development of products such as modified PP and environment-friendly modified plastics.
 
On March 31, 2011, Harbin Xinda established a wholly-owned subsidiary, Harbin Xinda Macromolecule Material Testing Technical Co., Ltd. (“Testing Technical”), to develop a nationally recognized testing laboratory and provide testing services of macromolecule materials, engineering plastics and other products.
 
In response to our rapid business expansion and in order to be eligible for tax relief for certain regions in China, we developed a group restructuring plan to re-calibrate our organization in late 2011. From August to December of 2011, Harbin Xinda established (i) Harbin Meiyuan Enterprise Management Service Company Limited. (“Meiyuan Service”) in Harbin to provide all year round training to both our existing and new employees, accommodate our customers and business partners as well as host industry conferences; and (ii) Heilongjiang Xinda Enterprise Group Technology Center  Company Limited (“Xinda Group Technology Center”) in Harbin to focus on long-term research and development projects. Heilongjiang Xinda Enterprise Group Company Limited. (“Xinda Group”), a wholly-owned subsidiary of HK Engineering Plastics Company Limited and the proposed direct parent company of all of our PRC-based operating subsidiaries after the group restructuring was established in December 2011. Harbin Xinda Plastics Material Research Center Company Limited (“Xinda Material Research Center”) was established in December 2011 to focus on research and development of products close to commercialization phase. Three companies, Haikou Xinda Plastics New Materials Company Limited. (“Haikou New Materials”), Haikou Xinda Plastics New Materials Enterprise Technical Center Company Limited (“Haikou Technical Center”), and Haikou Xinda Software Development Company Limited (“Haikou Software”) were established in December 2011 and are based in Haikou, the capital of Hainan province in the PRC. Part of the restructuring plan is for Harbin Xinda to transfer its ownership of subsidiaries to Xinda Group.  As of December 31, 2011, we have completed internal transfer of three subsidiaries to Xinda Group: Xinda Software, Xinda Group Technology Center and Testing Technical as shown in the organization chart below. Harbin Xinda will be deregistered and merged into Xinda Group. In addition, Xinda Engineering Center and Xinda Macromolecule Research Center shown in the organization chart as of December 31, 2011 will be deregistered and their functions including research and development will be carried out by Xinda Group Technology Center and Xinda Material Research Center. Meiyuan Service will change its name to Heilongjiang Xinda Enterprise Group Meiyuan Training Center Co. Ltd. (“Meiyuan Training”) to better reflect its nature of operation upon completion of the restructuring. Two new subsidiaries, Harbin Xinda Plastics Composite Material Company Limited (“Xinda Composite”) and Harbin Xinda Plastics New Material Company Limited (“Harbin New Material”) are planned to be established before the completion of the restructuring. Our restructuring is expected to be completed by the end of 2012.
 
2
 
 

 
 
Corporate Structure The corporate structure of the Company as of December 31, 2011 is as follows:
 
 
 
 
 
3
 
 

 
 
The planned corporate structure of the Company after the restructuring is as follows:

 

 
4
 
 

 
Our Industry
 
According to a research report prepared exclusively for the Company and issued by Frost & Sullivan in January 2012, China consumed approximately 12.7 million Metric Ton (“MT”) of modified plastic products in 2010, representing an increase of 35.9% compared to 2009. With China being the world’s leading manufacturing center and with rising domestic personal consumption, we believe that demand for modified plastics from China will continue to increase in the foreseeable future. As shown in Figure 1, the market demand for modified plastics will reach 13.1 million MT in 2011 and 18.5 million MT in 2015, representing compound annual growth rates (“CAGR”) of 7.8% and 11.9% by sales volume and revenue from 2010 to 2015.  Currently, demand for our products is primarily driven by the Chinese automotive industry. The use of modified plastics in the auto industry started in the 1950s. In order for plastics to be used in automobile parts and components, they must satisfy specific physical criteria in terms of mechanical functionality, stability under light and heat, durability, flame resistance, and environmental friendliness. Modified plastics are usually found in interior materials, door panels, dashboards, mud flaps, chassis, bumpers, oil tanks, gas valves, grilles, unit heater shells, air conditioner shells, heat dissipating grids, wheel covers, and other components.
 
Figure 1: Analysis of Chinese Modified Plastics Market: Sales Volume and Revenue (China), 2005-2015E
 
 
 
Source: Frost & Sullivan
 
According to Frost & Sullivan’s report, the Chinese automotive modified plastics market has experienced rapid development from 2005 to 2010, with more than a six-fold growth in terms of revenue and more than a four-fold increase in terms of sales volume during this period. The market demand is projected to reach 2.1 million MT in 2011. As illustrated in Figure 2, the Chinese automotive modified plastics market is expected to sustain rapid increase in terms of revenue and sales volume, with CAGR of 18.8% and 14.2% from 2010 to 2015, respectively. Approximately 51% of the automotive modified plastic consumed in 2010 was imported from outside of the PRC or manufactured by multinational and joint venture companies. We believe that the demand for automotive modified plastic in China will grow continuously due to the fast growing Chinese automotive market, increasing use per unit of plastic content in automobiles and favorable government incentives and regulations. Moreover, domestic producers will likely gain larger market share from imports as they are able to manufacture products with comparable quality at highly competitive prices and close proximity to their customers. We believe that the following are the key drivers for the automotive modified plastic industry in China.
 
 
5
 
 

 
Figure 2: Analysis of Chinese Automotive Modified Plastics Market: Sales Volume and Revenue (China), 2005-2015E
 
 
Source: Frost & Sullivan
 
Continual Growth in Chinese Auto Demand
 
According to the statistics by the China Association of Automobile Manufacturers (“CAAM”) in 2011, China’s production volume of automobiles increased from 5.7 million units in 2005 to 18.4 million units in 2011 as shown in Figure 3 below. The market is expected to sustain the growth with a CAGR of 5.9% from 2010 to 2015, reaching 24.3 million units in 2015. China has exceeded the United States to become the world’s largest auto market as measured by the number of automobiles sold. We believe the growth momentum in China’s auto sales will remain strong over the next five years. The automotive industry in China is still in its infancy with passenger car ownership of 28 vehicles per 1,000 inhabitants in 2009, which is significantly below the developed countries’ average of 445 and global average of 132 according to the Economist Intelligence Unit.
 
Figure 3: Overview of Chinese Marco Economy: Growth of Automotive Production (China), 2005-2015E
 
 
 
 
Source: China Association of Automobile Manufacturers, OICA, Frost & Sullivan
 
 
According to the National Bureau of Statistics, the total number of Chinese automobile parts has experienced a rapid growth because of the economic development and the incentive policies issued by the government. The number maintained a booming trend from 31.8 million units in 2005 to 78.0 million units in 2010, and is forecasted to hit a record of 93.4 million units in 2011 and 192 million units by 2015, with a CAGR of 19.8% between 2010 and 2015 as shown in Figure 4.
 
6
 
 

 
Figure 4: Overview of Chinese Macro Economy: Growth of Automotive Parts, 2005-2015E
 
Source: National Bureau of Statistics
 
Rising personal income in China is one of the key drivers for the rapid growth of the Chinese automobile industry. As shown in Figure 5, China has shown strong economic growth with its GDP increasing from approximately RMB 18,493.7 billion in 2005 to RMB 47,156.4 billion in 2011, and is expected to sustain the steady growth from 2012 to 2015. Per Capita Consumption Expenditure of Urban Household also shows an optimistic picture with a total nominal increase of 69.6% between 2005 and 2010, and is forecasted to reach RMB 22,551.6 by the end of 2015. Moreover, cars have become more affordable in China as local or joint venture automobile manufacturers continuously expand their production to achieve economies of scale to lower production cost and source cheaper auto parts locally. Growing income and decreasing vehicle prices will continually make car ownership more affordable for China’s rising middle class.
 
 
Figure 5: Overview of Chinese Macro Economy: Growth of Nominal GDP and Per Capita Consumption Expenditure of Urban Household (China), 2005-2015E
 
Source: National Bureau of Statistics, International Monetary Fund, and Frost & Sullivan
 
7
 
 

 
Benefit and Increasing Use of Plastic in Automobiles
 
(1) Cost Reduction: The primary demand driver for modified automotive plastics arises out of the cost-reduction characteristics evidenced by the plastics material inclusion in the automobile manufacturing process. Modified plastics can deliver the same performance as metallic materials at approximately a tenth of the cost. In addition, modified plastics can substitute some kinds of more expensive engineering plastics. This benefit of modified plastics will become more significant with the increased competition in automobile manufacturing industry to increase efficiencies and lower the cost.
 
(2) Vehicle Emissions Reduction: Plastic components impact fuel efficiency by saving approximately 2.5 liters of fuel per kilograms (kg) used (equivalent to 6kg of CO2 emissions) over the lifetime of the vehicle. Automobile manufacturers have been reducing vehicle weights in an attempt to reduce emissions and increase efficiencies. Modified plastics reduce the weight of components by 40% compared with traditional metallic materials.
 
(3) Performance and Safety Improvement: The development of advanced plastics applications lead to the improvement in performance through reducing the number and weight of the vehicle parts, thus the fuel consumption per vehicle drops significantly. In addition, the lower net weight of the vehicles improves handling performance and thereby, eliminates the likelihood of losing control in case of emergency stops. The involvement of modified plastics in automotive applications results in significant improvement of the safety features of the vehicle parts, like seat belts, air bags, and air bag containers in the recent years.
 
(4) New Applications: Plastics reduce the number of the required parts used in automobile manufacturing and introduce new design possibilities. Conventional materials struggle to compete against this open innovation platform associated with the plastics industry. In addition, the performance benefits associated with plastic materials continue to create a competitive advantage for the plastics industry.
 
(5) Increasing Use of Plastics per Vehicle: Weight of modified plastics per vehicle in China continually increased from 2005 to 2010, and is forecasted to reach 152.0 kg by the end of 2015, with a growth rate of 45.5% as shown in Figure 6. Although the weight of modified plastics per vehicle in China will still be less than that in North America and Europe, the highest growth rate indicates the huge potential for market growth. In 2010, plastic use in China is estimated to be about 104.5 kg per vehicle, representing 8% of the vehicle weight, whereas models imported from Europe contain on average as much as 190.0 kg per vehicle, or 15% of the vehicle weight. In addition, the Chinese government’s goals regarding electric and hybrid vehicles may also push the market further as weight concerns are more important for these vehicles than for traditional passenger cars. 
 
 
8
 
 

 
Figure 6: Comparison of Weight of Modified Plastics per Vehicle in (China, North America, and Europe), 2005, 2010, 2015E
 
 
 
Source: Frost & Sullivan, American Chemistry Council’s Plastics Industry Producers' Statistics Group
 
Increasing Substitution of Imports
 
Though China’s automotive plastic market has been dominated by foreign or joint venture (“JV”) companies, Chinese suppliers are continually gaining market share. It is estimated that automotive plastics imported and manufactured by multinational and JV companies accounted for 51.0% of the total China automotive plastic supply in 2010, decreasing from 65.0% in 2005 according to a report by Frost & Sullivan. Compared to foreign competitors including JV companies, local manufacturers can largely benefit from the lower cost and geographical convenience in China and their product sales can be customized with time-efficient after sales services and technical supports. As the local production capacity of both domestic and foreign companies has been expanding, share of imports is expected to decrease to 10.0% and that of multiple national companies (the “MNC”) and JV companies is expected to decrease to 25% by the end of 2015, while the share of domestic manufacturers is forecast to rise to 65.0% in 2015 as they expand at a greater rate than MNC and JV in China.
 
The financial crisis beginning in 2008 and the European debt crisis beginning in 2011 forced global automakers and suppliers to concentrate on their cost structure and pricing mechanisms. Many automakers accelerated cost reduction initiatives. Moving manufacturing operations to and sourcing raw materials from low cost regions have emerged as key measures to save costs. With its huge consumer market, low labor costs and high-quality manufacturing and logistics infrastructure, China is a location favored by global auto and component makers who source parts and components not only for their local operations in China but also for their global operations. As a result, we believe that China’s local plastic suppliers will benefit from such global outsourcing trends and increasingly become a good substitute for expensive imported plastic products. JV manufacturers based in China in automotive plastics sector have been slow to invest and expand in China.
 
Favorable National Government Policies
 
In the past decade, the Chinese government has adopted a number of policies and initiatives intended to encourage the development of the Chinese modified plastics industry and stimulate the growth of the Chinese automobile industry. 
 
9
 
 

 
Since 2000, modified plastics, including engineering plastics, have been categorized as a prioritized industrialization area by a series of government guidelines or development plans. Some of these policies include: 
 
●        
It was stated in the “Outline of China’s Twelfth Five-year Plan (2011)” that new functional materials, advanced structural materials, common base materials, fiber of high performance and its compounded material are key development directions of new material industry.
 
●        
It was stated in the “Catalogue for Guidance on Adjustment of Industrial Structure (2011)” promulgated by the National Development and Reform Commission on March 27, 2011, that the country is currently promoting the development of production equipment of polycarbonate by the use of non-phosgene method, with annual output of 60000t/year and above, production of engineering plastic including liquid crystalline polymer (LCP) and development and application of bleeding modification and alloying; development and production of water – absorbed resin, conductible resin and biodegradable polymers; development and production of new polyamide including nylon 11, nylon 1414 and nylon 46, nylon with long carbon chain and heat resistant nylon
 
  ●
It was stated in the “Guidance on Key Areas of Industrialization of High Technology with Current Priority in Development (2011)” jointly promulgated by the National Development and Reform Commission, the Ministry of Science and Technology, the Ministry of Commerce and the State Intellectual Property Office on June 23, 2011 that modified technologies applied to general plastics, including new engineering plastics and plastic alloy, new special engineering plastics, fire resistant modified plastics, and modified technology of general plastics, are currently prioritized areas to develop and industrialize in China’s macromolecule materials sector.
 
●        
 
       
A series of modified plastics technologies have been listed in the “National Support for Key High-tech Fields” as stated in the Circular on the Issuance of the Administrative Measure for the Recognition of High-tech Enterprise jointly promulgated by the Ministry of Science and Technology, Ministry of Finance, the State Administration of Taxation in April 2008. These technologies include special engineering plastics, macromolecular compound or new synthetic modified, etc.
 
In addition, with the Chinese government strongly encouraging the production of more fuel-efficient and environmentally friendly vehicles, as one means to fight the nation’s choking big-city pollution, opportunities abound for suppliers of plastics materials and auto components.
 
We believe that the above government measures and programs will continue to accelerate the demand for automotive modified plastics in China.
 
Tightening Trend and Local Government Policies
 
Despite the favorable national government policies as set forth above, in the past couple of years, the Chinese government has implemented certain measures to control the pace of economic growth and discontinued certain stimulus measures implemented to deal with the recent global financial crisis, including incentives for consumers to purchase automobiles.
 
10
 
 

 
Since 2011, in order to resolve the extreme traffic congestion, Beijing government has been implementing a vehicle purchase quota policy, which limits the maximum vehicles sold in Beijing per month to 20,000. Other cities which have begun to show signs of traffic congestion have also begun to implement similar measures to control traffic congestion, including the limited automobile licenses policy implemented in Shanghai and the imposition of congestion charges in Shenzhen.  The termination of nation-wide preferential policies can negatively affect consumer demand for new vehicles, and local restrictive measures over automobile purchases in major cities may result in the reduction in the sale of vehicles nationwide.
 
Our Products
 
Modified plastic is processed by adding chemical agents to basic plastics to generate or improve certain physical and/or chemical characteristics of plastic, such as heat resistance, hardness, tensile strength, wear resistance, and flame resistance. Based on the type of materials, modified plastics include modified common plastics, such as polypropylene (PP), acrylonitrile butadiene styrene (ABS), modified engineering plastics, such as polyamides (PA or nylon), environment-friendly plastics and specialty engineering plastics.
 
Our products are organized into seven categories, based on their physical characteristics, as set forth below:
 
 
Product Group
 
 
Brand Name
 
Number of Products Certified
 
 
Characteristics
 
Automotive or Other Application
Modified PP
 
COMPNIPER
   
40
 
High fluidity and impact resistance
 
Interior parts, such as inner panels, instrument panels and box lids
                   
   
COMPWIPER
   
51
 
Resistance to low temperature and impact
 
External parts, such as front and back bumpers and mudguards
                   
   
COMPGOPER
   
37
 
Resistance to high temperature and static
 
Functional components, such as unit heater shells and air conditioner shells
                   
Modified ABS
 
MOALLOLY
   
12
 
High gloss, high rigidity and size stability
 
Functional components such as heat dissipating grids and wheel covers
                   
Modified PA
 
POLGPAMR
   
14
 
High wear and heat resistance
 
Parts requiring high flame and heat resistance
                   
Engineering Plastics
 
MOAMIOLY
   
17
 
Heat resistance and wear resistance
 
Engine hoods, intake manifold and bearings
                   
Alloy Plastic
 
BRBSPCL
   
19
 
Combines two different plastics, such as PP and ABS
 
Rearview mirrors, grilles, automotive electronics and other components. Products can also be used in computers, plasma TVs and mobile phones
                   
Environmentally friendly plastics
 
POLGBSMR
   
21
 
Environmentally-friendly features such as low odor and low carbon emission
 
Used in automobiles meeting environmental standard requirements
                   
Modified Plastic for Special Engineering
 
PEEK
   
N/A *
 
Excellent mechanical and chemical resistance and temperature tolerance
 
Used in communications and transport, electronics and electrical appliances, machinery, medicaland analytical equipment.
                   
Total
       
211
       
 
 * PEEK is primarily used in applications that are unrelated to automotive applications, which does not require certifications and is in the product development stage.
 
11
 
 

 
Raw Materials
 
The principal raw materials used for the production of our modified plastic products are plastic resins such as polypropylene, ABS and nylon. Polypropylene is a chemical compound manufactured from petroleum.  ABS is a common thermoplastic used to make light, rigid, molded products such as automotive body parts and wheel covers.  Nylon is a thermoplastic silky material.  Approximately 50.4% of our raw materials are sourced from overseas petrochemical enterprises and 49.6% from domestic petrochemical enterprises during the year ended December 31, 2011.
 
The Company has one-year renewable contracts with its major suppliers, which are distributors of petrochemical enterprises. Because the raw materials used in our products are primarily petroleum products, the rise in oil prices directly affects the cost of the raw materials. We attempt to mitigate the increase in our raw materials prices by appropriately raising the price for our products to pass the cost to our customers as part of our pricing policy.
 
Because raw materials constitute a substantial part of the cost of our products, we seek to reduce costs by dealing with three major suppliers. During the year ended December 31, 2011, the Company purchased approximately 98.1% of the Company’s raw material purchases from three major suppliers. By dealing in large quantities with these major suppliers, we obtain reduced prices for raw materials, therefore reducing the cost of our products. If we were unable to purchase from these suppliers, we believe we would still have adequate sources of raw materials from other petrochemical distributors at similar cost.
 
Research and Development The Xinda Engineering Center and Xinda Macromolecule Research Center were organized to provide us with ongoing additions to our technology through advanced development methods, which represent the key to our competitive strength and success. Our goal is to utilize our state-of-the-art methods, equipment and our technical expertise to produce plastics of the highest quality that are cost-efficient for our customers. Toward this end, we have staffed the Xinda Engineering Center and Xinda Macromolecule Research Center with 37 employees who have Ph.D. and Master’s degrees and 57 employees who have Bachelor’s degrees. On average, our employees have been employed in our industry for more than three years, and our key R&D employees have on average more than 10 years of experience in our industry.
 
To supplement the efforts of our Xinda Engineering Center and Xinda Macromolecule Research Center, we have cooperated with a number of the leading technology institutions in China. Besides providing specialized research and development skills, these relationships help us to formulate cutting edge research programs aimed at developing new technologies and applications in plastics engineering.
 
All our significant research and development activities are overseen by the members of our Scientific Advisory Board, which we have assembled from the leaders in China’s chemical engineering industry.  Currently, the members of the Scientific Advisory Board are:
 
·  
Jin, Yong: Member of Chinese Academy of Engineering, Dean of Chemical Science Department of Tsinghua University.
·  
Lei, Qingquan: Member of Chinese Academy of Engineering, Post-PhD Advisor of Harbin Institute of Technology.
·  
Wu, Zhongwen: Chief Scientist and Director of the Research Institute of Special Plastics Engineering of Jilin University.
·  
Zheng, Kai: Secretary General of China’s Plastics Engineering Industry Association.
·  
Zhang, Huixuan: Vice Principal of Changchun University of Technology.
·  
Li, Bin: Dean of the Science Department at Eastern Forest Industry University.
 
12
 
 

 
·  
Jiang, Zhenhua: Director of the Engineering Research Center of the Special Plastics Engineering Education Department of Jilin University.
·  
Jing, Xiabin: Post-PhD Advisor and Researcher of Changchun Institute of Applied Chemistry of the Chinese Academy of Sciences.
·  
Wang, Guibin: Post-PhD Advisor of Jilin University.
·  
Li, Feng: Senior Engineer of Sinopec, Beijing Chemical Engineering Institute.
·  
Wang, Yafeng: Engineer Harbin Institute of Technology-Asset Management.
 
We host our annual seminar on the Development of the Macromolecule Materials Industry since 2008, during which we bring our prominent industry-leading consultants to meet our R&D staffs. The annual seminar gives industry experts an opportunity to review and evaluate the Company's R&D initiatives in terms of technology advancement on the backdrop of government policies which support development of the modified plastics industry. During the seminar, industry experts assess the progress of the Company's R&D projects for the current year, and then evaluate the Company’s R&D projects for next year. Projects are reviewed in terms of overall strategy, alignment with government policies, market opportunities, efficient utilization of R&D and technical feasibility. 
 
Our Xinda Engineering Center and Xinda Macromolecule Research Center are located within the same facility of our Dalian North Road production base. Both centers provided technical support for our recently expanded modified plastic annual theoretical production capacity of 255,000 MT and ongoing service to our customers, and enhanced our research and development capabilities for modified plastics in new applications in areas, such as aerospace, high-speed rail and new energy vehicles. We have been certified as a National Level Enterprise Technology Center, the only institution certified as such in the modified plastics industry in Heilongjiang. This certification makes us eligible for participation of issuing modified plastics industry standards, certain tax and tariff relief for scientific research and development, certain funding designated for National Enterprise Technology Center and municipal subsidies and Post-PhD and Academy Member WorkStation in Heilongjiang Province.
 
We spent US$11,640,243 and US$7,382,507 in research and development during the years ended December 31, 2011 and 2010, respectively.
 
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Intellectual Property
 
Patents
 
As a result of our collection of academic and technological expertise, we have two approved patents and 24 pending patent applications in China, as set forth in the following table.
 
 No.
Patent Name
Application No.
Application Date and Status
1
A preparation method of polycarbonate blends with high toughness and high strength
201110094454.6
April 15, 2011, pending
       
2
A preparation method of glass fiber reinforced polyether ether ketone with high strength and high heat resistance
201110122566.8
May 12, 2011, pending
       
3
A rapid detection methods of the tensile propertie of modified PP used in auto specially by non-standard situation
201110158528.8
June 14, 2011, pending
       
4
A preparation process of centralized control method used in plastic production line
201110158488.7
June 14, 2011, pending
       
5
A rapid detection methods of the impact propertie of midified plastics used in automobile specially
201110233488.9
August 16, 2011,pending
       
6
A preparation process of the premixed screening system
201110158488.7
December 1, 2011,pending
       
7
A preparation process of the plastic production line with high performance and high homogeneity
201110233488.9
December 1, 2011,pending
       
8
A preparation method of the thermoplastic elastomers PP with high mobility and high  resistance of deformation
201110035725.0
February 11, 2011,pending
       
9
A preparation method of polylactic acid used in auto dashboard
201110035716.1
February 11, 2011,pending
       
10
A preparation method of polymer composites with high toughness
201110035736.9
February 11, 2011,pending
       
11
A special material of cooling grille with high heat resistance and high weather resistance
201110094466.9
April, 15, 2011,pending
       
12
A preparation process of ABS alloy with high impact performance and high heat resistance
201110122586.5
May, 12, 2011,pending
 
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13
A preparation method of easily dispersed and easily processing polypropylene composite material
201110158511.2
June 14, 2011,pending
       
14
A preparation method of high heat-resistant  and high rigid PLA composite material reinforced by fully biodegradable natural fiber
201110158512.7
June 14, 2011,pending
       
15
A high impact PA6 composite material with core-shell toughening and its preparation method
201110196226.X
July 13, 2011,pending
       
16
A high-powered aircraft tail composite material and its preparation process
201110196209.6
July 13, 2011,pending
       
17
A preparation method of polypropylene resin foam particles with supercritical CO2 act
201110230302.4
April, 12, 2011,pending
       
18
A high toughness,low warpage and high-mobility PET/PBT/PC alloy reinforced by glass fiber and its preparation method
201110235189.9
April, 17, 2011,pending
       
19
A high impact and high heat-resistant flame retardant ABS composite material reinforced by glass fiber and its preparation process
201110268625.2
September 13, 2011,pending
       
20
A preparation method  of polylactic acid composite material modified by hydroxyapatite with supercritical water act
201110268687.3
September 13, 2011,pending
       
21
A high heat-resistant and high wear-resistant PEEK composite material and its preparation process
201110347338.0
October 1, 2011,pending
       
22
A preparation process of high weathering colour ASA resin
201110347336.1
November, 2011,pending
       
23
A high toughness, low warpage and low mold temperature PET/PA6 alloy reinforced by glass fiber and its preparation method
2011110347339.5
November, 2011,pending
       
24
A polypropylene composite material used in  battery tank of new source of energy  automobile and its preparation method
201110347320.0
November, 2011,pending
       
25 A modified method of bond interface between carbon fiber and non-polar resin ZL200510010279.2 June 6, 2007 approved
       
26 A sprayed directly material used in car bumper ZL20081005170.8 January 12, 2011 approved
 

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Trademark
 
We own the trademarks for our graphic logo and Chinese characters of “Xinda”, which we use in packaging our products and marketing ourselves.
 
Certification Process
 
To meet the requirements of an automobile manufacturer, products used as component parts must pass a rigorous certification process by the manufacturer’s technological quality assurance department before they can be approved for and used in production. The certification process consists of three stages.
 
First, the automobile manufacturer reviews the manufacturer of modified plastics.  The examination involves assessment of the operation history of the modified plastics manufacturer, their experience in providing component services, the specialization of their factory equipment, their research and development capacity and quality assurance systems. The manufacturer’s operations need to meet the requirements of the automobile manufacturer. Once the initial review is passed, the modified plastics manufacturer will obtain a qualification as an automobile component manufacturer. This initial stage takes approximately sixteen to twenty two months to complete.
 
Second, the automobile manufacturer and the manufacturer of modified plastics reach an understanding about a product specification. The modified plastics manufacturer provides product research and development materials to the automobile manufacturer for inspection. The automobile manufacturer tests the product specification according to its standards and, if results are satisfactory, the modified plastics manufacturer obtains a product specification certification and enters the product certification stage. The second stage takes approximately eight months to complete.
 
Third, the parties complete technology R&D tests and perform automobile component finished parts tests.  The product undergoes additional testing by the automobile manufacturer and is used in road tests. This stage takes approximately five to fifteen months depending on whether the car model is an existing model or a new model. At the conclusion of the third stage, the modified plastics manufacturer receives a product certification from the automobile manufacturer.
 
We believe that the necessity, rigorousness, complexity and duration of the certification process make it difficult for outside competitors to enter the field in a short period of time. We have obtained 211 certifications from automobile manufacturers as of December 31, 2011 which we believe is currently one of the largest portfolios of product certifications in the Chinese automobile modified plastics industry.
 
Sales and Marketing
 
Currently, our sales network focuses on the northeastern, northern and eastern regions of China. We primarily sell to end customers through our approved distributors.  To a less extent, we also sell directly to end customers.  A typical customer development cycle starts when our R&D staffs develop customized products for new customers and obtain product certifications. These customers are usually major automobile parts manufacturers who can only source from suppliers like China XD with product certifications granted by major automobile manufacturers. After  we established relationships with these customers and began to have large volume of transactions with them, we assign the customers to our distributors according to our internal policies. In 2011, approximately 96.8% of our sales were generated from distributors.
 
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We enter into distribution agreements with local distributors in areas where large automobile manufacturers are located. The distribution agreements usually have a term of three years, during which period we can enter into distribution agreements with other distributors for our products. The distributors are responsible for marketing and distributing our products. Through the established sales channels, we can quickly respond to local market demand, address customer needs, enhance our ability to provide technical support and after-sales services, and lower our marketing expenses. Our general credit term with our distributors is three months and our collection of payment from distributors is not contingent upon their cash collection from end customers. We manufacture products according to orders received from our distributors and maintain a certain quantity of raw materials based on our experience and the distributors order patterns. By doing this we hope to ensure the smooth implementation of the production plan of major automobile manufacturers and avoid risks of inventory shortage.  We do not provide the distributors nor end customers with the right of return, price protection or any other concessions.  We allow for an exchange of products or return only if the products are defective.
 
We have been actively extending our distribution network to seven distributors in 2011 and we believe we have good control on our distribution network.  We believe that we have been able to secure and maintain strong relationships with our customers due to our existing certifications, advanced technologies and high product quality, which establish a higher barrier to entry. Most of the new customer relationships will be developed through our own R&D and sales force and maintained by our R&D and sales professionals, and our distributors.  According to our distribution contracts, our distributors are prohibited from selling our competitors’ products and required to use the product certificate, brand name and package standards set by us during the distribution period. After the expiration of the distribution contracts in absence of renewal, we retain the customer relationships with end customers.
 
Fluctuation in the cost of raw materials affects the selling price of our products.  According to our sales contracts, after we receive a sales order, if the increase or decrease in the procurement prices of plastic resin, our key raw material, is over 5%, we will adjust the prices of our products by the same amount of the increase or decrease of the raw materials. As a result, we are able to pass on most of the increase in the cost of our raw materials to our customers. The actual monthly orders by our distributors may vary from our annual contract, though the variation is usually small.
 
The Company sells its products, substantially through approved distributors in the PRC.  The Company’s sales to its distributors are highly concentrated. Sales to four and three major distributors, which individually exceeded 10% of the Company’s revenues, accounted for approximately 73.7% and 73.3% of the Company’s revenues for the years ended December 31, 2011 and 2010, respectively. The Company expects revenues from these distributors to continue to represent a substantial portion of its revenue in the future.
 
Competition
 
The PRC automotive modified plastics industry is growing rapidly and highly fragmented with the top three domestic producers occupying less than approximately 22.1% of the market shares in 2010 according to the Frost & Sullivan’s report. According to Frost & Sullivan’s report, in terms of sales volume and production capacity, we are one of the leading domestic specialized manufacturers of modified plastic for automobile parts in China, with a market share of approximately 5.4% in 2010 and 7.2% in 2011. In 2011, our sales volume of automotive plastics was approximately 151,000 MT. As of December 31, 2011, our annual production capacity of automotive plastics was 165,000 MT.
 
We installed 20 new product lines on December 11, 2011. The 20 new production lines will be utilized primarily for the manufacture of higher value-added modified plastics products. Once fully ramped up, the lines will increase the Company's total production capacity by 90,000 MT to 255,000 MT per annum. The additional capacity will start to contribute to the Company's production capacity during the first quarter of 2012.
 
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Currently, Harbin Xinda’s primary Chinese competitor in the automobile industry is Guangzhou Kingfa Science & Technology Co., Ltd. (“Guangzhou Kingfa”). Guangzhou Kingfa entered the automotive modified plastics market in 2006 and its facilities had an annual manufacturing capacity of 169,000 MT for its modified plastics products used in the automobile industry at the end of 2010. Kingfa has the largest capacity expansion plans and is expected to expand to 472,000 MT by 2012, but its utilization rate of production capacity is expected to be lower than that of China XD based on Frost & Sullivan’s report. Guangzhou Kingfa has much larger financial resources than Harbin Xinda. However, we believe that it currently holds fewer number of product certifications for automotive modified plastic to the automobile industry compared to Harbin Xinda. Another top domestic manufacturer of modified plastic is Shanghai Pret Composites Co., Ltd. (“Shanghai Pret”), which focuses on the production of automotive plastics. According to Frost & Sullivan’s report, it had an annual capacity of 61,800 MT and sales volume of 50,600 MT in 2010.
 
The Chinese auto market predominantly uses modified plastics manufactured overseas or in factories controlled by foreign companies, such as manufacturers from Germany, the Netherlands and Japan. Although China’s automotive plastic market is dominated by foreign or JV players, Chinese suppliers are continually gaining market share. It is estimated that automotive plastics imported or manufactured by multinational and JV companies accounted for approximately 51% of the total China automotive plastic supply in 2011, decreasing from 65% in 2005. JV manufacturers based in China in automotive plastics sector have been slow to invest and expand in China. Compared to foreign competitors including JV manufacturers, domestic manufacturers can benefit from the lower costs and geographical proximity in China. As local players continue to invest in research and development, enhance product quality and improve management skills, we believe that domestic production of automotive plastic will compete very favorably with the foreign competitors in terms of price, quality, services and delivery times and continually replace imported plastics.
 
Our Competitive Strengths
 
We believe that the following competitive strengths continue to enable us to compete effectively in the automotive modified plastics market in the PRC:
 
 
Leading Market Position with High Barrier to Entry. We believe that we are one of the China’s leading specialized manufacturers of modified plastic for automobile parts in terms of sales volume and production capacity, with a market share of approximately 7.2% in 2011. The PRC automotive modified plastics industry is growing rapidly and is highly fragmented with the top three domestic producers occupying less than approximately 22.1% of the market shares in 2010. In 2011, our sales volume of automotive plastics was approximately 151,000 MT, representing a growth of 33.0% compared to that in 2010. As of December 31, 2011, our annual production capacity of automotive plastics was 165,000 MT. We believe our leading market position allows us to successfully compete with other foreign and domestic modified plastic manufacturers in the market. Being one of the leading specialized manufacturer of automotive modified plastics in China, we believe we are well-positioned to not only grow with the increasing market demand but increase market share by replacing smaller and less efficient modified plastic manufacturer.
 
In addition, as a result of our consistent research and development efforts, we have obtained 211 product certifications from major automotive manufacturers in the PRC as of December 31, 2011, which we believe is among the largest numbers of product certifications by any domestic player in China’s automotive plastics industry. Strict certification requirements and long certification periods result in high barriers to entry. Our current or potential competitors are required to obtain relevant product certifications from automotive manufacturers in order to compete with us. Each certification normally takes over two years to complete, and as a result, automotive manufacturers are reluctant to change suppliers like us who have already received necessary certifications and proven consistent product quality. We believe that having one of the largest portfolios of product certifications in China allows us to strengthen our competitive position.
 
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Long-Term Relationships with Reputable End Users. Our senior management has been involved in the business of modified plastics since 1985. We benefit from the industry connections and experience of our senior management, which have enabled us to establish long-term customer relationships and strong industry recognition. We are a qualified provider of high-quality automotive plastics, and have sold our products through plastic auto part manufacturers to many leading automotive manufacturers in China. Currently, our modified plastics are utilized in more than 20 automobile brands and over 70 automobile models manufactured in China, including Audi, Volkswagen, BMW, GM Mazda, Toyota, Cherry, Geely and Hafei new energy vehicles.. We believe that our brand and our products are well recognized and respected in China’s automotive modified plastics market.
 
High Quality Products with Lower Costs.  We purchase our raw materials from a small number of large suppliers who procure resins locally or internationally.  By concentrating our purchases from a small group of suppliers, we are able to keep the costs of purchasing raw materials relatively low.  Also, since our manufacturing facilities are located in China where labor, raw materials and operation costs are relatively lower, we are able to charge lower prices than our international competitors while maintaining comparable quality. Compared to our domestic competitors, we believe our long-standing manufacturing experience, in-depth market knowledge, significant scale of economy and strong R&D capabilities enable us to provide higher quality products at competitive prices.
 
Manufacturing facilities are critical to the quality of products. We have in the past invested substantial time and resources in building state-of-the-art production lines to enhance our product quality. Our facilities have maintained ISO/TS16949, a certification of quality management systems specific to the automotive industry. 
 
Strong Customer-Oriented R&D Capabilities. The modified plastics industry is characterized by rapid development and increasing demand for high quality products. We have strong R&D capabilities that allow us to have successfully passed OEM automakers’ certification processes in the past and continually introduce new and high quality products to the market. Compared to international plastic supply models, which target larger scale applications of common plastics and involve less customization and specialization, we provide customer-oriented product development through our certification process.  By working closely with our customers, we are able to adjust our product features to better satisfy the specific needs of each customer. To achieve this, we have staffed our R&D team with 94 professionals, of whom 37 have Ph.D. and Master’s degrees. On average, our R&D employees have worked with us for more than three years, and some key experts have more than 10 years of experience in our industry. We have also cooperated with a number of the leading technology centers in China. Besides providing specialized research and development skills, these relationships help us to formulate cutting edge research programs aimed at developing new technologies and applications in plastics engineering.  We currently have two approved patents and have 24 patent applications pending with the State Intellectual Property Office of the P.R.C., or SIPO.
 
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Established Distribution Model.  Through seven distributors across China, we have established distribution networks that cover northeast, north and east China, with a current focus on northeast China. We enter into distribution agreements with local distributors in areas where large automobile manufacturers are located.  By leveraging the proximity of our distributors to the automobile manufacturers, we can enhance our relationships with our customers. Through the established sales channels, we can quickly respond to local market demand, address customer needs, enhance our ability to provide superior technological support and after-sales services, and lower our marketing expenses.  At the same time, our distributors are responsible for the payments to us which is not contingent upon their cash collection from end customers. By actively managing our distribution network, we are also able to accelerate local market penetration and increase sales opportunities. For example, we entered the north China market in 2009 through a local distributor, one year earlier than we planned, and in 2011 north and east China account for approximately 18.4% and 19.2% of our revenues, respectively.
 
 
Seasoned Management Team.  Our senior management team and key personnel have extensive operating and industry experience. Mr. Han, our chief executive officer and president, founded our former affiliate Harbin Xinda Nylon Factory in 1985. With 27 years of industry experience, Mr. Han has in-depth knowledge and expertise of China’s modified plastic industry. He currently serves as executive director of the China Plastic Processing Industry Association and as a member of the Standing Committee of the Heilongjiang Association of Industry and Commerce. Our chief executive officer, chief technology officer and chief operating officer have over 50 years combined experience in the modified plastics industry and we believe their extensive professionalism and knowledge can well serve our customers.
 
 
Sufficient Capital Resources. We received US$100 million investment from MSPEA Modified Plastics Holding Limited, a Cayman Islands company and an affiliate of Morgan Stanley (“MSPEA”), one of the leading private equity investors in Asia, for a significant non-controlling ownership stake in the Company in 2011. The proceeds from this investment will help us expand and further upgrade our production capabilities. In addition, as the holder of Series D Preferred Stock, MSPEA is entitled to appoint and has appointed two directors to our Board, who are able to contribute their extensive transactions experience to help the Company with acquisition opportunities to expand our production capacity and our business into overseas markets.
 
Our Strategies
 
Our goal is to capitalize on China’s modified plastics growth trend, with a specific focus on applications in the auto sector, and to eventually be the leading modified plastics manufacturer in China. We are committed to enhancing our sales and profitability and achieving our goals through the following strategies:
 
 
Continue to Increase Production Capacity.  Over the past five years, we have consistently increased production capacity to meet the rising demands of the automotive industry in the PRC. As of December 31, 2011, we have an installed annual production capacity of 165,000 MT, and we have been operating at near full capacity since 2007. With the expected strong growth in the automotive modified plastics market of China, we expect that we will continue to experience strong demand from our customers. Therefore, we intend to continue to strategically increase our production capacity to meet customer demands from both expanded geographical location and future downstream sector growth. We plan to continually increase our annual capacity to reach approximately 300,000 MT by 2013 and approximately 500,000 MT by 2015.
 
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Focus on R&D and Develop New Product Offerings.  We are currently utilizing our research and development capabilities to obtain further product certifications, develop new products, applications and technologies. Approximately 29.5% of our automotive plastic product certification applications are currently undergoing trial manufacturing periods to obtain the necessary certifications. In addition, we are developing new products for automotive applications to expand our product portfolio, including initiating R&D on modified plastic for use in electric vehicles. We are also developing specialty engineering plastics and bio-plastics for use in other applications, such as high-speed trains, vessel-propulsion systems, mining and oil-field equipment and aerospace equipments. We have operated a new research center since May 2011. We are the first non State-Owned-Enterprise awarded National Level Enterprise Technology Center, in Heilongjiang Province. In addition, we have Post-PhD and Academy Member WorkStation in Heilongjiang Province enhancing our research and development capabilities.
 
Expand Customer Base Domestically and Internationally.  The automotive plastics market in the PRC is highly fragmented with significant barriers to entry. Although we have approximately 7.2% of the market share in 2011, our customer coverage is concentrated in the northeast regions of the PRC. We seek to increase our market share in northeast China, and also expand our reach to northern and eastern China. In addition, we intend to have sales in overseas markets and export our products by 2013. We plan to implement such strategies through further expanding our distribution network by working with local distributors who have contacts and networks overseas and directly establishing strategic alliances with certain of our non-PRC customers.
 
Pursue Selective Strategic Acquisitions.  While we have experienced substantial organic growth, we plan to pursue a disciplined and targeted acquisition strategy to accelerate our growth. Our strategy will focus on strengthening presence in certain geographies, improving our penetration in attractive markets, enhancing research and development capabilities and acquiring new markets or customers.
 
Increase Efficiency by Corporate Restructuring. We are currently implementing a corporate restructuring plan with the aim of establishing a more efficient company group structure, as a result of which every subsidiary will be more easily accessible to the customers and our operation will respond to the market changes in a more efficient manner. We aim to complete the corporate restructuring plan by the end of 2012.
 
Environmental Laws
 
The cost of compliance with Chinese environmental regulations currently is minimal. Most of the waste produced from our production process is water, which we circulate in our enclosed water treatment system.  
 
Employees
 
China XD’s operations are organized into several operational departments including manufacturing, Research & Development (“R&D”), management, finance, sales, purchasing and marketing and others. As of December 31, 2011, there were 537 employees, including 213 in manufacturing, 94 in R&D, 89 in management, 19 in finance, 48 in sales, purchasing and marketing and 74 in other departments.
 
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ITEM 1A.   RISK FACTORS
 
In addition to the other information in this Form 10-K, readers should carefully consider the following important factors. These factors, among others, in some cases have affected, and in the future could affect, our financial condition and results of operations and could cause our future results to differ materially from those expressed or implied in any forward-looking statements that appear in this on Form 10-K or that we have made or will make elsewhere.
 
The global economic crisis could further impair the automotive industry thereby limiting demand for our products.
 
The continuation or intensification of the recent global economic crisis arising from the European debt crisis may adversely impact our business, and the businesses of our customers. Our specialized plastics are sold to automobile parts manufacturers and distributors. The recent global economic crisis harmed most industries and has been detrimental to the automotive industry. Since virtually all of our sales are made to auto industry participants, our sales and business operations are dependent on the financial health of the automotive industry and could suffer if our customers experience, or continue to experience, a downturn in their business. Presently, it is unclear whether and to what extent the economic stimulus measures facilitated by the European Union and other governments throughout the world will mitigate the effects of the crisis on the automotive industry and other industries that affect our business.
 
We concentrate our operations primarily in the automotive industry, therefore, a contraction in automotive sales and production could have a material adverse effect on our results of operations and liquidity.
 
We develop, manufacture, and distribute modified plastic, primarily for use in automobiles. Automotive sales and production are highly cyclical and depend, among other things, on general economic conditions and consumer spending and preferences (which can be affected by a number of issues including fuel costs and the availability of consumer financing). As the volume of automotive production fluctuates, the demand for our products also fluctuates. While the China automotive sales and production maintained growth momentum in 2010 and continued to grow in 2011, however the growth rate was significantly down from previous years. A contraction in automotive sales and production could harm our results of operations and financial condition. Consequently, we are exposed to the risks of adverse developments affecting the auto industry to a greater extent than if our operations were dispersed over a variety of industries.
 
The withdrawal of preferential government policies and the tightening control over the Chinese automotive industry and automobile purchase restrictions imposed in certain major cities may limit market demand for our products.
 
In 2011, Chinese government terminated two preferential policies for its automotive industry: (1) vehicles with 1.6L or lower air displacement were given a 50% discount in purchase tax and (2) the vehicles sold in rural area were given a government subsidy. Since 2011, in order to resolve the extreme traffic congestion, the Beijing government has been implementing the vehicle purchase quota policy, which limits the maximum vehicles sold in Beijing per month to 20,000. Other cities which have begun to show signs of traffic congestion have also begun to implement similar measures to control traffic congestion, including the limited automobile licenses policy implemented in Shanghai and the imposition of congestion charges in Shenzhen. The termination of two nation-wide preferential policies negatively affected consumer demand for new vehicles, and local restrictive measures over automobile purchases in major cities may result in the reduction in the sale of vehicles nationwide.  According to Rao Da, secretary-general of China Passenger Vehicle Association as reported on February 3, 2012, China’s total new automobile sales to end-users in 2011 were down 7 percent compared to those in 2010. The national and local policies over the Chinese automotive industry may continue to impact market demand for automobiles in 2012 and eventually result in a reduction in our product sales.
 
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The Chinese automotive industry's growth is slowing after the rapid growth since 2000 and such slowdown may adversely affect the market demand for our products.
 
There is a direct correlation between our business and automobile production volume and sales, which are dependent on economic policies and market sentiment. The Chinese automotive industry had been rapidly growing for a decade prior to 2011. However, inflation, higher interest rates, tighter bank lending, lifting of consumer subsidies and buying restrictions in congested cities all contributed to a more modest environment in 2011, resulting in the sharp slow-down in automobile sales volume growth rate to 3%, compared to 46% in 2009 and 34% in 2010, representing the lowest growth rate in the past 13 years, according to the latest data issued by China Association of Automobile Manufacturers. Any significant reduction in automobile production and sales would have a material and adverse effect on our business.  There can be no assurance that the market conditions, government policies and other factors leading to the existing slowdown in demand for automobiles will not continue.  The decline in demand for automobiles would directly and adversely affect demand for our products and hence our business, financial condition and results of operations.
 
In the event we do not comply with our obligations under our loan agreements with Longjiang Bank and Bank of Communication, which loans are secured by our land use rights, certain buildings and machinery, our business may be adversely affected and disrupted.
 
Harbin Xinda has entered into short term loan agreements with Longjiang Bank and Bank of Communication. The loans are secured by (i) Harbin Xinda’s land use right, buildings and machinery, and (ii) equipment of Harbin Xinda High-Tech Co., Ltd. (“Xinda High-Tech”), a related party as collateral and also guaranteed by Mr. Jie Han and his spouse. Although we are in compliance and intend to continue to be in compliance with the payment terms and our other obligations under the loan agreements, we may not be able to repay these loans.  In the event of a default on these obligations, Longjiang Bank and Bank of Communication may seize control over the pledged collateral, as a result of which our business may be adversely affected and disrupted.
 
A large percentage of our sales revenue is derived from sales to a limited number of distributors and a limited number of customers, and our business will suffer if sales to these customers decline.
 
A significant portion of our sales revenue historically has been derived from a limited number of distributors. Our top four and three distributors accounted for approximately 73.7% of our revenues in 2011 and approximately 73.3% in 2010, respectively. Any significant reduction in demand for modified plastics by any of these major customers or our distributors and any decrease in demand of products by its customers could harm our sales and business operations, financial condition and results of operations.
 
We are dependent on a limited number of suppliers. While we have identified alternative sources for the materials and equipment we use, a temporary disruption in our ability to procure necessary materials and equipment could adversely impact our sales in future periods.
 
Materials constitute a substantial part of the cost of our products.  We seek to reduce the cost of raw materials by dealing with major suppliers. During the year ended December 31, 2011, the Company purchased approximately 98.1% of the Company’s raw materials from three major suppliers. The Company purchased equipment from one major supplier, which accounted for 99.7% of the Company's equipment purchases for the year ended December 31, 2011. We believe the relationship with our suppliers is satisfactory and that alternative suppliers are available if relationships falter or existing suppliers should become unable to keep up with our requirements. However, there can be no assurance that our current or future suppliers will be able to meet our requirements on commercially reasonable terms or within scheduled delivery times. An interruption of our arrangements with suppliers could cause a delay in the production of our products for timely delivery to distributors and customers which could result in a loss of sales in future periods.
 
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If we are subject to product quality or liability claims relating to our products, we may incur significant litigation expenses and management may have to devote significant time defending such claims, which if determined adversely to us, could require us to pay significant damage awards.
 
Although we have adopted certain internal measures to supervise and examine the quality of our products, we may be subject to legal proceedings and claims from time to time relating to our product quality. The defense of these proceedings and claims could be both costly and time-consuming and significantly divert the efforts and resources of our management. An adverse determination in any such proceedings could subject us to significant liability. In addition, any such proceeding, even if ultimately determined in our favor, could damage our market reputation and prevent us from maintaining or increasing sales and market share. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase of our products.
 
We have limited insurance coverage on our assets in China and any uninsured loss or damage to our property, business disruption or litigation may result in our incurring substantial costs.
 
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited insurance products. Other than automobile insurance on certain vehicles and property and casualty insurance for some of our assets such as factories and equipments we do not have insurance coverage on our other assets or inventories, nor do we have any business interruption, product liability or litigation insurance for our operations in China. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured loss or damage to property, business disruption or litigation may result in our incurring substantial costs and the diversion of our resources, which may have a material adverse effect on our results of operations, financial condition and/or liquidity.
 
SAFE regulations relating to offshore investment activities by PRC individuals may increase our administrative burden and restrict our overseas and cross-border investment activity. If our shareholders and beneficial owners who are PRC individuals fail to make any required applications, registrations and filings under such regulations, we may be unable to distribute profits and may become subject to liability under PRC laws.
 
The State Administration of Foreign Exchange, or “SAFE”, has promulgated several regulations, including Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents to Engage in Financing and Inbound Investment via Oversea Special Purpose Vehicles, or the “Circular No. 75,” issued in November 2005 and certain implementation rules issued in recent years, requiring registrations with, and approvals from, PRC government authorities in connection with direct or indirect offshore investment activities by PRC residents and citizens individuals.
 
In May 2011, SAFE enacted “Circular of the State Administration of Foreign Exchange on Printing and Distributing on the Operating Rules for the Administration of Foreign Exchange with Respect to the Financing and Round-tripping Investment of Domestic Residents via Overseas Special Purpose Companies” (“Circular No. 19”). Circular No. 19 does not change the registration requirements imposed by Circular No. 75, but clarifies and simplifies the registration procedures. These regulations apply to our shareholders and beneficial owners who are PRC individuals.
 
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The Circular No. 75 requires PRC individuals to register with relevant local branches of SAFE for their establishment or control of any oversea special purpose vehicles, or the “SPVs,” or the contribution of assets of or their equity interests in any domestic company to any SPV, or any material changes of the SPVs.  Failure to make the required SAFE registration may result in penalties including that our PRC subsidiaries may be prohibited from making distributions of profit to the SPV and from paying the SPV proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries.
 
We have requested our shareholders and beneficial owners who are PRC individuals to make the necessary applications and filings as required under these regulations and under any implementing rules or approval practices that may be established under these regulations. As of the date of this Annual Report on Form 10-K, Mr. Han, our chief executive officer’s beneficial ownerships in China XD and XD. Engineering Plastics Company Limited respectively have been registered with local SAFE in accordance with Circular No. 75 and Circular No. 19. However we cannot assure you that the rest of our shareholders and beneficial owners who are PRC individuals have timely updated their registrations with SAFE. The failure or inability of our PRC shareholders and beneficial owners make any required registrations may subject us to fines and legal sanctions, restrict our overseas or cross-border investment activities, limit our PRC subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, as a result of which our acquisition strategy and business operations and our ability to distribute profits to you could be materially and adversely affected.
 
On December 25, 2006, the People’s Bank of China issued the Administration Measures on Individual Foreign Exchange Control, and the corresponding Implementing Rules were issued by SAFE on January 5, 2007, both of these regulations became effective on February 1, 2007. According to these regulations, all foreign exchange matters relating to employee stock holding plans, share option plans or similar plans in which PRC citizens will participate require approval from SAFE or its authorized branch. On March 28, 2007, SAFE issued the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rule. Under the Stock Option Rule, Chinese citizens who were granted share options or shares by an offshore listed company were required, through a Chinese agent or Chinese subsidiary of the offshore listed company, to register with SAFE and complete certain other procedures. We are an offshore listed company and, as a result, we and our Chinese employees who had been granted share options or shares under our existing share incentive plan were subject to the Stock Option Rule. We did not obtain a registration with the local SAFE in Heilongjiang in connection with the options we granted to our PRC employees under our existing share incentive plan, because local SAFE in Heilongjiang orally informed us that we were not required to obtain such registration with it, and that we only needed to apply for verification in connection with establishment of a foreign exchange account and purchase of foreign currency when our employees planned to sell incentive shares or to exercise options.
 
In February 2012, SAFE promulgated the Notice on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly-Listed Company, or the New Stock Option Rules, which replaced and substituted the Stock Option Rule. According to the New Stock Option Rules, if a PRC resident participates in any stock incentive plan of an overseas publicly-listed company, a qualified PRC domestic agent must, among other things, file on behalf of such participant an application with SAFE to conduct the SAFE registration with respect to such stock incentive plan and obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with the exercise or sale of stock options or stock such participant holds. Such participating PRC resident’s foreign exchange income received from the sale of stock and dividends distributed by the overseas publicly-listed company must be fully remitted into a specific domestic foreign currency account opened and managed by such PRC agent first, before distribution to such participants.
 
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We are an offshore listed company and, as a result, any Chinese employee, or foreign employee who resides in PRC more than one year consecutively, of our PRC subsidiaries, including without limitation, directors, supervisors and other senior management staffs of our PRC subsidiaries, who have been granted share options or shares under our existing share incentive plan are subject to the New Stock Option Rules.  We will make an application with local SAFE in Heilongjiang to obtain a registration in respect of our incentive share plan in accordance with the New Stock Option Rules. If our PRC subsidiaries or their qualified employees fail to comply with these regulations, including the New Stock Option Rules, they may be subject to fines or other legal sanctions imposed by SAFE or other Chinese government authorities.
 
Under the PRC EIT Law, we and/or Favor Sea BVI may be classified as a “resident enterprise” of the PRC. Such classification could result in tax consequences to us, our non-PRC resident shareholders and Favor Sea BVI.
 
On March 16, 2007, the National People’s Congress approved and promulgated a new tax law, the PRC Enterprise Income Tax Law, or “EIT Law,” which took effect on January 1, 2008. Under the EIT Law, enterprises are classified as resident enterprises and non-resident enterprises. An enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” and subject to the uniform 25% enterprise income tax rate on global income. The implementing rules of the EIT Law define “de facto management bodies” as a managing body that in practice exercises “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise; however, due to the short history of the EIT Law and lack of applicable legal precedents, it remains unclear whether the PRC tax authorities would deem our managing body as being located within China, or whether we or our non-PRC subsidiaries would be deemed as resident enterprises of the PRC.
 
If the PRC tax authorities determine that we, Favor Sea Limited, a British Virgin Islands corporation (“Favor Sea BVI”) and/or Hong Kong Engineering Plastics Company Limited, a Hong Kong corporation (“HK Engineering Plastics”), are “resident enterprises” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow.  We, Favor Sea BVI and/or HK Engineering Plastics may be subject to enterprise income tax at a rate of 25% on our, Favor Sea BVI and/or HK Engineering Plastics’s worldwide taxable income, as well as PRC enterprise income tax reporting obligations. However, under the EIT Law and its implementing rules, dividends paid between “qualified resident enterprises” are exempt from enterprise income tax. As a result, if we, Favor Sea BVI and HK Engineering Plastics are treated as PRC “qualified resident enterprises,” all dividends paid from Harbin Xinda to HK Engineering Plastics, from HK Engineering Plastics to Favor Sea BVI and from Favor Sea BVI to us may be exempt from PRC tax. 
 
On April 22, 2009, State Administration of Taxation (the “SAT”) enacted “Circular of the State Administration of Taxation on Issues Concerning the Identification of Chinese-Controlled Overseas Registered Enterprises as Resident Enterprises in Accordance With the Actual Standards of Organizational Management”. On July 27, 2011, SAT enacted “Announcement of the State Administration of Taxation on Printing and Distributing the Administrative Measures for Income Tax on Chinese-controlled Resident Enterprises Incorporated Overseas (Trial Implementation)”. Under those two rules, either the enterprises may request the PRC tax authorities to determine their “resident enterprises” identity or the tax authority may investigate and determine an enterprise’s identity.   The target enterprises under those two rules are foreign registered companies controlled by the PRC companies, however, the PRC tax authority may determine if a foreign registered company controlled by the PRC individual(s) is a “resident enterprise” or not by reference to those two rules.
 
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If we, Favor Sea BVI and HK Engineering Plastics are treated as PRC “non-resident enterprises” under the EIT Law, then dividends that HK Engineering Plastics receives from Harbin Xinda (assuming such dividends were considered sourced within the PRC) (i) may be subject to a 5% PRC withholding tax, if the Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (the “PRC-HK Tax Treaty”) were applicable, or (ii) if the PRC-HK Tax Treaty does not apply (i.e., because the PRC tax authorities may deem HK Engineering Plastics to be a conduit not entitled to treaty benefits), may be subject to a 10% PRC withholding tax. Similarly, if we and Favor Sea BVI were treated as PRC “non-resident enterprises” under the EIT Law, and HK Engineering Plastics were treated as a PRC “resident enterprise” under the EIT Law, then dividends that Favor Sea BVI receive from HK Engineering Plastics (assuming such dividends were considered sourced within the PRC) may be subject to a 10% PRC withholding tax; if we were treated as a PRC “non-resident enterprise” under the EIT Law, and Favor Sea BVI and HK Engineering Plastics were treated as PRC “resident enterprises” under the EIT Law, then dividends that we receive from Favor Sea BVI (assuming such dividends were considered sourced within the PRC) may be subject to a 10% PRC withholding tax. Any such taxes on dividends could materially reduce the amount of dividends, if any, we could pay to our shareholders.
 
Finally, if we were deemed as a “resident enterprise,” the new “resident enterprise” classification could result in a situation in which an up to 10% PRC tax is imposed on dividends we pay to our non-PRC shareholders that are not PRC tax “resident enterprises”. In such event, we may be required to withhold an up to 10% PRC tax on any dividends paid to non-PRC resident enterprise shareholders. Our non-PRC resident enterprise shareholders also may be responsible for paying PRC tax at a rate of 10% on any gain realized from the sale or transfer of our ordinary shares in certain circumstances if such income is considered PRC-sourced income by relevant tax authorities. We would not, however, have an obligation to withhold PRC tax with respect to such gain.
 
On December 15, 2009, the State Administration of Taxation (“SAT”) released Circular Guoshuihan No. 698 (“Circular 698”) that reinforces the taxation of non-listed equity transfers by non-resident enterprises through overseas holding vehicles. Circular 698 is retroactively effective from January 1, 2008.  Circular 698 addresses indirect share transfer as well as other issues.  According to Circular 698, where a foreign (non-PRC resident) investor who indirectly holds shares in a PRC resident enterprise through a non-PRC offshore holding company indirectly transfers equity interests in a PRC resident enterprise by selling the shares of the offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of its residents is not taxable, the foreign investor is required to provide the PRC tax authority in charge of that PRC resident enterprise with certain relevant information within 30 days of the transfer. The tax authorities in charge will evaluate the offshore transaction for tax purposes. In the event that the tax authorities determine that such transfer is abusing forms of business organization lack of reasonable commercial purpose or for purpose of avoidance of PRC income tax liability, the PRC tax authorities will have the power to re-assess the nature of the equity transfer under the doctrine of substance over form. If the relevant tax authority’s challenge of a transfer is successful, it may disregard the existence of the offshore holding company that is used for tax planning purposes and require seller to pay PRC tax on the capital gain from such transfer.  Since Circular 698 has a short history, there is uncertainty as to its application. We (or a foreign investor) may become at risk of being taxed under Circular 698 and may be required to expend valuable resources to comply with Circular 698 or to establish that we (or such foreign investor) should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations (or such foreign investor’s investment in us).
 
If any such PRC taxes apply, a non-PRC resident shareholder may be entitled to a reduced rate of PRC taxes under an applicable income tax treaty and/or a foreign tax credit against such shareholder’s domestic income tax liability (subject to applicable conditions and limitations). Prospective investors should consult with their own tax advisors regarding the applicability of any such taxes, the effects of any applicable income tax treaties, and any available foreign tax credits. 
 
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PRC regulations relating to mergers and acquisitions of domestic enterprises by foreign investors may increase the administrative burden we face and create regulatory uncertainties.

On August 8, 2006, six PRC regulatory agencies, namely, the PRC Ministry of Commerce, or the MOFCOM, the State Assets Supervision and Administration Commission, or the SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission, or the CSRC, and the SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006. The M&A Rule purports, among other things, (i) to require any PRC company, enterprise or individual that intends to merge or acquire its domestic affiliated company in the name of an overseas company which it lawfully established or controls, to apply for MOFCOM’s  examination on and approval for the  proposed merger or acquisition; and (ii) to require SPVs, formed for overseas listing purposes through acquisitions of PRC domestic companies and controlled by PRC companies or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange. Interpretation and enforcement of the M&A Rule in terms of offshore listing by SPVs always remain uncertain. As a result, we are not sure whether the M&A Rule would require us or our entities in China to obtain the approval from either the MOFCOM or the CSRC or any other regulatory agencies in connection with the transaction contemplated by the share transfer contracts which were entered into between Mr. Jie Han, Mr. Qingwei Ma and Hong Kong Engineering Plastics Company Limited on June 26, 2008 , the transaction contemplated in the Agreement and Plan of Merger entered into by and among NB Telecom, Favor Sea (BVI) and the shareholders of Favor Sea (BVI) on December 24, 2008 (detailed description of both of the two aforesaid transactions and relevant contracts can be found in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, filed on April 14, 2010) the adoption and performance of the option agreement dated May 16, 2008 between Ms. Piao and Mr. Han.
 
Further, if the PRC government finds that we or our Chinese stockholders did not obtain the MOFCOM or CSRC approval, which the MOFCOM or CSRC may think we should have obtained before executing the aforesaid agreements, we could be subject to severe penalties. The M&A Rule does not stipulate the specific penalty terms, so we are not able to predict what penalties we may face, and how such penalties will affect our business operations or future strategy.
 
Our business will suffer if we cannot obtain or maintain necessary permits or approvals.
 
Under PRC laws, we are required to obtain from various PRC governmental authorities certain permits and licenses in relation to the operation of our business. These permits and licenses are subject to periodic renewal and/or reassessment by the relevant PRC government authorities and the standards of compliance required in relation thereto may from time to time be subject to change. We cannot assure you that we can always obtain, maintain or renew all the permits and licenses in a timely manner. Additionally, any changes in compliance standards, or any new laws or regulations that may prohibit or render it more restrictive for us to conduct our business or increase our compliance costs may adversely affect our operations or profitability. Any failure by us to obtain, maintain or renew necessary licenses, permits and approvals, could subject us to fines and other penalties and limit the business we could conduct, which could have a material adverse effect on the operation of our business. In addition, we may not be able to carry on business without such permits and licenses being renewed and/or reassessed.
 
Pursuant to PRC laws and regulations, construction or expansion of a building or a production facility is subject to various permits and approvals from different government authorities. In connection with the construction of Harbin Xinda’s factory and production facilities, which has already been completed and put into operation, we obtained a project approval from Administration Committee of Harbin Economic and Technological & High-tech Development Zone and an approval for the environmental impact assessment report on the construction project of Harbin Xinda in 2003. However, certain other necessary permits relating to the construction and operation of Harbin Xinda’s factory and production facilities are outstanding. Failure to obtain all necessary approvals/permits may subject us to various penalties, such as fines or being required to vacate from the facilities where we currently operate our business.
 
 
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Increased environmental regulation in China could increase our costs of operation.
 
Certain processes utilized in the production of modified plastics result in toxic by-products. To date, the Chinese government has imposed only limited regulation on the production of these by-products, and enforcement of the regulations has been sparse. Recently, however, there is a substantial increase in focus on the Chinese environment, which has inspired considerable new regulation. Because Harbin Xinda plans to export plastics to the U.S. and Europe in coming years, Harbin Xinda has developed certain safeguards in its manufacturing processes to assure compliance with the environmental protection standard ISO/TS16949 Quality Assurance Standard, the European Union’s RoHS Standards and Germany’s PAHs Standards.  Furthermore, we are in the process of applying for the U.S.’s UL Safety Certification, ISO14001 Environmental Management System Certification and OHSAS18001 Occupational Health Management System Certification. This compliance regimen brings us into compliance with all Chinese environmental regulations. Additional regulation, however, could increase our cost of doing business, which would impair our profitability.
 
We may fail to develop and maintain an effective system of internal controls over financial reporting.  As a result, we may not be able to accurately report our financial results or prevent fraud and current and potential shareholders could lose confidence in the integrity of our financial reports, which could harm our business and the trading price of our common stock.
 
Prior to our listing on the US stock exchange, we were a private company with all business operations within China. Our accounting and reporting system was designed to satisfy local statutory requirements and internal management needs. We had limited accounting personnel and resources to address internal control over financial reporting for the purpose of compliance with U.S. GAAP and SEC reporting requirements. Management concluded that our internal controls over financial reporting were ineffective as of December 31, 2011, due to a  material weakness and a significant deficiency. The material weakness relates to insufficient competent accounting personal in applying U.S. generally accepted accounting principles, in particular, accounting for Series D preferred stock and application of two class method in the calculation of earnings per share. The significant deficiency relates to our lack of tax expertise to review the income taxes of the entities in the People’s Republic of China (the “PRC”) and the United States of America (the “USA”).
 
Our management is committed to strengthening our internal controls and complying with Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX 404”).  In 2011, we continued to implement a plan, pursuant to which (1) our accounting staff obtained external training of US GAAP and SEC reporting by qualified entity in 2011, (2) we have hired a third party SOX 404 compliance consultant to help us improve our internal controls system, and (3) we continue to seek senior qualified people with requisite expertise and knowledge to help improve our internal control procedures.  
 
However, we cannot be certain that these measures we have undertaken will ensure that we will maintain adequate controls over our financial processes and reporting in the future. Furthermore, if we are able to rapidly grow our business, the internal controls that we will need may become more complex, and significantly more resources may be required to ensure our internal controls remain effective. Failure to implement required controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we fail to maintain an effective internal control system, our stockholders and other potential investors may lose confidence in our business operations and the integrity of our financial statements, and may be discouraged from future investments in our company, which may delay or hinder any future business development or expansion plans if we are unable to raise funds in future financings, and our current stockholders may choose to dispose of the shares of common stock they own in our company, which could have a negative impact on our stock price. In addition, non-compliance with SOX 404 could subject us to a variety of administrative sanctions, including the suspension of trading of our stock on the NASDAQ Global Market, ineligibility for listing on other national securities exchanges, and the inability of registered broker-dealers to make a market in our common stock, which could further reduce our stock price.
 
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We may be subject to or liable to US taxes, interest and penalties.
 
Because we do not generate any income in the U.S., we do not believe that we owe U.S. federal income taxes for the taxable years ended December 31, 2011 and 2010. However, there can be no assurance that the IRS will agree with this position, and therefore we ultimately could be held liable for U.S. federal income taxes, interest and penalties.
 
Our inability or failure to protect our intellectual property rights may significantly and materially impact our business, financial condition and results of operations.
 
Protection of our proprietary processes, methods and other technology is important to our business. We generally rely on a combination of the patent, trademark and copyright laws of the PRC and laws protecting trade secret in the PRC, as well as licenses and non-disclosure and confidentiality agreements, to protect our intellectual property rights. The patent, trademark and copyright laws of the PRC, as well as laws protecting trade secret in the PRC, may not protect our intellectual property rights to the same extent as the laws of the U.S.
 
Failure to protect our intellectual property rights may result in the loss of valuable proprietary technologies. Additionally, some of our technologies are not covered by any patent or patent application and, even if a patent application has been filed, it may not result in an issued patent. If patents are issued to us, those patents may not provide meaningful protection against competitors or against competitive technologies. In addition, upon the expiration of patents issued to us, we will be unable to prevent our competitors from using or introducing products using the formerly-patented technology. As a result, we may be faced with increased competition and our results of operations may be adversely affected. We cannot assure you that our intellectual property rights will not be challenged, invalidated, circumvented or rendered unenforceable.
 
We also rely upon unpatented proprietary manufacturing expertise, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we generally enter into confidentiality/non-disclosure agreements with our employees and third parties to protect our intellectual property, we cannot assure you that our confidentiality/non-disclosure agreements will not be breached, that they will provide meaningful protection for our trade secrets and proprietary manufacturing expertise or that adequate remedies will be available in the event of an unauthorized use or disclosure of our trade secrets or manufacturing expertise.
 
Our intellectual property rights may be challenged or infringed upon by third parties or we may be unable to maintain, renew or enter into new license agreements that are important to our business with third-party owners of intellectual property on reasonable terms. We could also face patent infringement claims from our competitors or others alleging that our processes or products infringe on their proprietary technologies. If we are found to be infringing on the proprietary technology of others, we may be liable for damages, and we may be required to change our processes, to redesign our products partially or completely, to pay to use the technology of others or to stop using certain technologies or producing the infringing product(s) entirely. Even if we ultimately prevail in an infringement suit, the existence of the suit could prompt customers to switch to products that are not the subject of infringement suits. We may not prevail in any intellectual property litigation and such litigation may result in significant legal costs or otherwise impede our ability to produce and distribute key products.
 
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We may be unable to renew the leases for our factories on acceptable terms or these leases may be terminated.
 
As of December 31, 2011, Harbin Xinda operated three separate factories located at 9 Qinling Road (the “Qinling Road Factory”), at 9 North Dalian Road (the “Dalian Road Factory”) and at 9 Jiangnan First Road (the “Jiangnan Road Factory”). Harbin Xinda owns the titles to the land and premises of the Qinling Road Factory. Harbin Xinda leases land and premises of the Dalian Road Factory from Xinda High-Tech. In addition, the Xinda Engineering Center leased an office building at the Dalian Road Factory from Xinda High-Tech. Harbin Xinda is in the process of acquiring the titles to the land and premises at Jiangnan Road Factory. Harbin Xinda and the Xinda Engineering Center’s leases will expire on April 30, 2012 and May 31, 2013 respectively. If we are unable to renew our lease on acceptable terms in due course or if our lease is terminated by the lessor unilaterally for the Dalian Road Factory or acquire the titles to the land and premises at Jiannan Road Factory:
 
·
 we may be unable to find a new property with the amenities and in the location we  require for our factories, which may result in a factory closure;

·
 we may have to relocate to a less desirable location;
  
·
 we may have to relocate to a location with facilities that do not meet our requirements;
 
·
 we may incur significant costs in connection with identifying, securing and relocating  to a replacement location; or
 
·
 our factories may experience significant disruption in operations and, as a result,  we may be unable to produce products during the period of disruption.
 
Any of these events may materially and adversely affect our business, prospects, results of operations and financial condition.
 
A sharp increase in the demand or the price for raw materials may have a negative impact on our results of operations if we are unable to pass on increases in the cost of raw materials to our customers on a timely basis.
 
The total cost of raw materials made up approximately 98% of our cost of revenues in both 2011 and 2010.
 
Currently, plastic resins are mainly used as a raw material in China’s plastic parts molding industry. The market prices of plastic resins may fluctuate due to changes in supply and demand conditions in that industry. Any sudden shortage of supply or significant increase in demand of plastic resins and additives may result in higher market prices and thereby increase our cost of sales. The prices of plastic resins and additives are, to a certain extent, affected by the price movement of crude oil. The international market prices for crude oil increased in 2011 compared to the fourth quarter of 2010 and continued to rise during the first two months of 2012, which caused the price of raw materials to increase. In addition, under the terms of our customer agreements, we can only increase the sales price for our products if the cost of our raw materials increases by more than 5%. As a result, our inability to increase the selling price of our products to cover increases of less than 5%, may limit our profitability.
 
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Our assets are primarily located in China. So any dividends or proceeds from liquidation are subject to the approval of the relevant Chinese government agencies.
 
Our assets are primarily located inside China. Under the laws governing FIEs in China, dividend distribution and liquidation are allowed but subject to special procedures under the relevant laws and rules. Any dividend payment will be subject to the decision of the Board of Directors and subject to foreign exchange rules governing such repatriation. Any liquidation is subject to both the relevant government agency’s approval and supervision as well the foreign exchange control. This may generate additional risk for our investors in case of dividend payment or liquidation.
 
Governmental control of currency conversions may affect the value of your investment.
 
All of our revenue is earned in Renminbi, and any future restrictions on currency conversions may limit our ability to use revenue generated in Renminbi to make dividend or other payments in U.S. dollars. Although the PRC government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises like us may buy, sell or remit foreign currencies only after providing valid commercial documents at a PRC banks specifically authorized to conduct foreign-exchange business.
 
In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in the PRC, and companies are required to open and maintain separate foreign-exchange accounts for capital account items. There is no guarantee that PRC regulatory authorities will not impose additional restrictions on the convertibility of the Renminbi. Such restrictions could prevent us from distributing dividends and thereby reduce the value of our stock.
 
The fluctuation of the exchange rate of the Renminbi against the dollar could reduce the value of your investment.
 
The value of our common stock will be affected by the foreign exchange rate between U.S. dollars and Renminbi. For example, to the extent that we need to convert U.S. dollars we receive from an offering of our securities into Renminbi for our operations, appreciation of the Renminbi against the U.S. Dollar could reduce the value in Renminbi of our funds. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.
 
On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. Dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of the Renminbi against the U.S. dollar of approximately 28.8% from July 21, 2005 to December 31, 2011. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. Dollar.
 
We receive all of our revenues in Renminbi. The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the China. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange (“SAFE”) by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where Renminbi are to be converted into foreign currency and remitted out of the PRC to pay capital expenses, such as the repayment of bank loans denominated in foreign currencies.
 
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The PRC government could also restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain expenses as they become due.
 
MSPEA Modified Plastics Holding Limited (“MSPEA”) has significant influence over our affairs.
 
MSPEA currently owns 100% of our outstanding Series D Preferred Stock, representing approximately 23.8% of our issued and outstanding shares of common stock on an as converted basis. Pursuant to the Certificate of Designation of Series D Preferred Stock, holders of Series D Preferred Stock have the right to elect, voting as a separate class, two directors to serve on the Board so long as at least 12,800,000 (adjusted for any dilutive corporate actions) shares of Series D Preferred Stock are outstanding, and one director to serve on the Board if the number of shares of Series D Preferred Stock outstanding at such time is less than 12,800,000 but more than 1,600,000 (in each case adjusted for any dilutive corporate actions). For so long as at least 1,600,000 (adjusted for any dilutive corporate actions) shares of Series D Preferred Stock remain outstanding, holders of Series D Preferred Stock have veto rights over certain material corporate actions of the Company and its subsidiaries as described in the Certificate of Designation of Series D Preferred Stock. As such, MSPEA currently has significant influence over our affairs.
 
Upon the occurrence of certain events, we may be required to redeem all or a portion of the Series D Preferred Stock.
 
The holders of the Series D Preferred Stock have the right to require us to redeem all or a portion of the outstanding shares of the Series D Preferred Stock, subject to certain restriction on the redemption date, at a price per share equal to an amount that would yield a total internal rate of return of 15% to such holder on the original issue price of $6.25 per share, upon the occurrence of any of the following events: (i) our failure to achieve an adjusted consolidated net income of RMB360 million for fiscal year 2011, or RMB468 million for fiscal year 2012, or RMB608 million for fiscal year 2013, (ii) a breach by us, XD Engineering Plastics or Mr. Han of certain provisions of the financing documents in connection with the issuance and sale of the Series D Preferred Stock, which breach gives rise to a material adverse effect on us or which materially diminishes the value of the Series D Preferred Stock, (iii) the commencement by the Company or any of its subsidiaries of any bankruptcy, insolvency, reorganization or the like, or (iv) the appointment of a custodian, receiver, liquidator, assignee, trustee or other similar officials of the Company or any of its subsidiaries for the winding up or liquidation of its affairs. In the event we are required to redeem the Series D Preferred Stock, if we have insufficient cash available and do not have access to bank debt, we may have to liquidate assets to fund such redemption. Any such liquidation may yield proceeds lesser than might otherwise be the case.
 
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ITEM 1B.    UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.  PROPERTIES
 
Physical Plant and Production
 
Our executive offices and production facilities are located in the Harbin Development Zone in the City of Harbin, which is the provincial capital of Heilongjiang Province in northeast China. Our owned facility has a total usable area of 7,359 square meters (79,212 square feet). The facility includes six buildings with one office building attached by one workshop, one workshop, one storage room, one transformer station, and two guard rooms. All the company’s properties are insured by China Pacific Property Insurances Co., Ltd.
 
The land on which our owned facility is located measures 14,715 square meters (158,391 square feet). The land use right was issued to Harbin Xinda by the City of Harbin and will expire in 2053. We also have a long-term lease of the production facilities with Xinda High-Tech. The land on which our leased facility is located measures 16,537 square meters (178,009 square feet). The facility we rent includes three buildings with two office buildings attached by one workshop respectively and one guard room. Cost of compliance with Chinese environmental regulations currently is minimal.
 
On May 9, 2011, Harbin Xinda entered into a purchase agreement with Harbin Shengtong Engineering Plastics Co. Ltd. (“Harbin Shengtong”) as amended on June 1, 2011.  The legal representative of Harbin Shengtong is a former employee of Harbin Xinda. Pursuant to the purchase agreement, Harbin Xinda will purchase from Harbin Shengtong land use rights and a production base consisting of five workshops and a building (the “Project”), in exchange for a total consideration of RMB435 million (approximately US$67.3 million) in cash. Harbin Shengtong is responsible to complete the construction of the plant according to Harbin Xinda’s specifications. Once the Project is fully completed and accepted by Harbin Xinda, Harbin Shengtong shall transfer titles of the Project to Harbin Xinda. The completion of the entire Project is expected to occur in the second half of 2012. During the year ended December 31, 2011, the Company paid Harbin Shengtong a cash deposit of RMB118.9 million (equivalent to US$18.9 million). In December 2011, two workshops were completed and subsequently placed into service by the Company. Accordingly, the cost of these two workshops of approximately RMB59.5 million (equivalent to US$9.5 million) was recorded in plant and buildings as of December 31, 2011.  The allocable cost of the land use right related to the two workshops of approximately RMB24.1 million (equivalent to US$3.8 million) was recorded in land use rights in the Company’s balance sheet as of December 31, 2011. The titles of the two workshops and the related land use rights are expected to be transferred to the Company once the Project is completed in the second half of 2012.
 
On June 13, 2011, China XD, through its subsidiary, Xinda Macromolecule Research Center entered into two equipment purchase contracts with Harbin Jiamu Import and Export Trading Co., Ltd., pursuant to which, Xinda Macromolecule Research Center purchased various production and R&D equipment for RMB 278 million (equivalent to approximately US$43 million). The production equipment was delivered and put into use before the end of 2011.  In December 2011, the 20 new production lines were opened and they will be utilized primarily for the manufacture of higher value-added modified plastics products. Once fully ramped up in the first quarter of 2012, the lines will increase the Company's total production capacity by 90,000 metric tons to 255,000 metric tons per annum. The additional capacity started contributing to the Company's production capacity during the first quarter of 2012.
 
34
 
 

 
The process of manufacturing modified plastic consists of modifying a standard plastic (polypropylene, ABS, PA6, PA66, etc.) by adding various agents and additives that will alter the physical and/or functional characteristics of the plastic. Catalysts are added that facilitate the desired chemical reactions, all of which occurs in a specially designed equipment. The resulting plastics are then extracted from the equipment by an extraction technique that is proprietary to Harbin Xinda. Further processing may involve additional blending, extrusion, cooling and cutting, homogenizing and packing, as needed to meet the customer’s requirements.
 
In addition to its unique extraction technology, Harbin Xinda has developed its own techniques and equipment for many of the steps in the production process. Among the aspects of production for which Harbin Xinda has proprietary technology are product formulae, a technique for combining extruder screws, and certain stuffing techniques. With these unique formulas and techniques, our products can satisfy clients’ standard requirements at a lower cost than competitive products.
 
Our facilities have been certified under the following international qualifications criteria: ISO9001: 2000 quality management system certification and ISO/TS16949: 2002 international auto parts industry quality systems certification. The government of China has designated Harbin Xinda as a National Torch Project and a National Spark Plan Project, and has given Harbin Xinda the “Most Valuable High Tech in China” award. Harbin Xinda is an executive member of the Council of the Chinese Automobile Parts Association, a member of the Chinese Modified Plastics Professional Committee, a member of the Chinese Plastics Engineering Committee and Heilongjiang Province Post Doctoral Working Station.
 
ITEM 3.   LEGAL PROCEEDINGS
 
None.
 
ITEM 4.   MINE SAFETY DISCLOSURES
 
Not applicable.
 
35
 
 

 
PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Prior to November 27, 2009, our common stock was quoted on the OTC Bulletin Board (“OTCBB”) under the symbol “CXDC”. On November 27, 2009, we terminated our listing on OTCBB and listed our common stock on NASDAQ Global Market, also under the symbol “CXDC.” The following table sets forth, for the indicated periods, the high and low sales prices for our common stock, as reported on NASDAQ.
 
  
 
Common Stock
 
   
High
   
Low
 
Fiscal Year Ended December 31, 2010
           
First Quarter
   
6.99
     
5.70
 
Second Quarter
   
7.35
     
5.11
 
Third Quarter
   
7.18
     
5.00
 
Fourth Quarter
   
6.84
     
5.01
 
                 
Fiscal Year Ending December 31, 2011
               
First Quarter
   
7.35
 
   
5.12
 
Second Quarter
   
5.67
     
3.18
 
Third Quarter
   
5.55
     
3.10
 
Fourth Quarter
   
5.41
     
3.78
 
 
Number of Holders
 
As of March 20, 2012, there were 361 record holders of our common stock.
 
Interwest Transfer Company Inc. is the registrar and transfer agent for our common shares. Its address is 1981 Murray Holladay Road, Suite 100, Salt Lake City, UT  84117 USA, telephone: (801) 272-9294.
 
Dividend Policy
 
We have not paid any cash dividends since our inception and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We expect to retain our earnings, if any, to provide funds for the expansion of our business. Future dividend policy will be determined periodically by the Board of Directors based upon conditions then existing, including our earnings and financial condition, capital requirements and other relevant factors.
 
Under current PRC regulations, wholly foreign-owned enterprises and Sino-foreign equity joint ventures in the PRC may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, these foreign-invested enterprises are required to set aside certain amounts of their accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends. Payment of future dividends, if any, will be at the discretion of our Board of Directors after taking into account various factors, including current financial condition, operating results and current and anticipated cash needs.
 
 
36
 
 

 
Securities Authorized for Issuance under Equity Compensation Plans
 
The Company adopted the 2009 Stock Option / Stock Issuance Plan (the “Plan”) on May 26, 2009, which reserved 7,800,000 shares of common stock for issuance under the Plan. The Plan allows the Company to issue awards of stock options and stock issuances to directors, officers, employees and consultants of the Company, which may be subject to restrictions.
 
The following table provides certain information with respect to the Company’s Plan in effect as of December 31, 2011.
 
Plan category
 
Number of securities to be issued upon exercise of outstanding options and nonvested shares
(a)
   
Weighted-average exercise price of outstanding options, warrants and rights
(b)
 
                 
Stock options
   
297,000
     
8.01
 
Nonvested shares
   
106,405
     
0
 
Total
   
403,405
         
 
As of December 31, 2011, the number of securities remaining available for future issuance under equity compensation plans was 5,413,715 shares.
 
Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities
 
On August 15, 2011, China XD Plastics entered into a securities purchase agreement (the “Securities Purchase Agreement”) with MSPEA Modified Plastics Holding Limited, a Cayman Islands company and an affiliate of Morgan Stanley (“MSPEA”), XD Engineering Plastics and Mr. Han, pursuant to which MSPEA purchased 16,000,000 shares of redeemable Series D convertible preferred stock with par value of US$0.0001 per share (the “Series D Preferred Stock”), for a total consideration of US$100 million or US$6.25 per share (“Series D Original Issuance Price”). On September 28, 2011, China XD Plastics issued 16,000,000 shares of Series D Preferred Stock and received total gross proceeds of US$100 million in cash. Net proceeds after issuance cost were approximately US$99.1 million.
 
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
On April 7, 2011, the Board of Directors approved a stock repurchase program that allows the Company to repurchase up to US$10 million of its stock until May 31, 2012. On September 28, 2011, the Company purchased 21,000 shares of its common stock in the public stock market for a total consideration of US$92,694.
 
ITEM 6.
SELECTED FINANCIAL DATA
 
 Not applicable.
 
 
37
 
 

 
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
We make forward-looking statements in this report, in other materials we file with the Securities and Exchange Commission (the “SEC”) or otherwise release to the public, and on our website. In addition, our senior management might make forward-looking statements orally to analysts, investors, the media and others. Statements concerning our future operations, prospects, strategies, financial condition, future economic performance (including growth and earnings) and demand for our products and services, and other statements of our plans, beliefs, or expectations, including the statements contained in this Item 7, “Management’s Discussion and Analysis or Plan of Operation,” regarding our future plans, strategies and expectations are forward-looking statements. In some cases these statements are identifiable through the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions. We intend such forward-looking statements to be covered by the safe harbor provisions contained in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and in Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You are cautioned not to place undue reliance on these forward-looking statements because these forward-looking statements we make are not guarantees of future performance and are subject to various assumptions, risks, and other factors that could cause actual results to differ materially from those suggested by these forward-looking statements. Thus, our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: economic conditions generally and the automotive modified plastics market specifically, legislative or regulatory changes that affect our business, including changes in regulation, the availability of working capital, the introduction of competing products, and other risk factors described herein. These risks and uncertainties, together with the other risks described from time-to-time in reports and documents that we filed with the SEC should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Indeed, it is likely that some of our assumptions will prove to be incorrect. Our actual results and financial position will vary from those projected or implied in the forward-looking statements and the variances may be material. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
 
General
 
China XD Plastics Company Limited (“China XD”, “we”, and the “Company”, and “us” or “our” shall be interpreted accordingly) is one of leading specialty chemical companies engaged in the research, development, manufacture and sale of modified plastics primarily for automotive applications in China. Through our wholly-owned subsidiary Harbin Xinda Macromolecule Material Co., Ltd. (the “Harbin Xinda”), we manufacture and sell modified plastics, primarily for use in the fabrication of automobile parts and components. We develop our products using our proprietary technology through our wholly-owned research laboratory, Harbin Xinda Macromolecule Material Research Center Co., Ltd. (the “Xinda Macromolecule Research Center). Xinda Macromolecule Research Center, a professional macromolecular material research and development institution and has received 211 certifications from manufacturers in the automobile industry as of December 31, 2011. We are the only company certified as a National Enterprise Technology Center in modified plastics industry in Heilongjiang Province. Our Research and Development (the “R&D”) team consists of 94 professionals and 11 consultants, including two consultants who are members of Chinese Academy of Engineering, and one consultant who is the former chief scientist of Specialty Plastics Engineering Institute of Jilin University.  As a result of the combination of our academic and technological expertise, we have a portfolio of 26 patents, two of which we have obtained the patent rights and the remaining 24 of which we have applications pending in China as of December 31, 2011.
 
 
38
 
 

 
We believe we are one of leading specialty chemical companies engaged in the research, development, manufacture and sale of modified plastics primarily for automotive applications in China. Our products include seven categories: polypropylene (PP), acrylonitrile butadiene styrene (ABS), modified engineering plastics, polyamides (PA or nylon), environment-friendly plastics, specialty engineering plastics and PEEK. The Company's products are primarily used in the production of exterior and interior trim and functional components of more than 20 automobile brands and 70 automobile models manufactured in China, including Audi, Volkswagen, BMW, GM Mazda, Toyota, Cherry, Geely and Hafei new energy vehicles. The Company's Research Center is dedicated to the research and development of modified plastics, and benefits from its cooperation with well-known scientists from prestigious universities in China. We operate three manufacturing bases in Harbin, Heilongjiang in the PRC. As of December 31, 2011, we had approximately 165,000 metric tons of production capacity across 38 automatic production lines utilizing German twin-screw extruding systems, automatic weighing systems and Taiwan conveyer systems. In December 2011, we successfully launched our third production base in Harbin with the 90,000 metric tons of production capacity across 20 new production lines installed in two completed factories. In addition, there are three additional factories which are currently in construction in our third production base and expected to be completed in the second half of 2012 and which could support our production capacity expansion beyond 2012.

Critical Accounting Policies
 
We prepare our consolidated financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of our assets and liabilities; (2) the disclosure of our contingent assets and liabilities at the end of each reporting period; and (3) the reported amounts of revenues and expenses during each reporting period. We continually evaluate these judgments, estimates and assumptions based on our own historical experience, knowledge and assessment of current business and other conditions and our expectations regarding the future based on available information which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

When reading our consolidated financial statements, you should consider our selection of critical accounting policies, the judgment and other uncertainties affecting the application of such policies, and the sensitivity of reported results to changes in conditions and assumptions. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements.

Long-Lived Assets

Our long-lived assets include property, plant and equipment and land use rights.

We depreciate and amortize our property, plant and equipment and land use rights, using the straight-line method of accounting over the estimated useful lives of the assets. We make estimates of the useful lives of property, plant and equipment, including the salvage values, and land use rights in order to determine the amount of depreciation and amortization expense to be recorded during each reporting period. We estimate the useful lives at the time the assets are acquired based on historical experience with similar assets.
 

 39
 
 

 
We evaluate long-lived assets, including property, plant and equipment, and land use rights for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. We assess recoverability by comparing carrying amount of a long-lived asset or asset group to estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated undiscounted future cash flows, we recognize an impairment charge based on the amount by which the carrying amount exceeds the estimated fair value of the asset or asset group. We estimate the fair value of the asset or asset group based on the best information available, including prices for similar assets and in the absence of an observable market price, the results of using a present value technique to estimate the fair value of the asset or asset group. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third party independent appraisals, as considered necessary.  Assets to be disposed are reported at the lower of carrying amount or fair value less costs to sell, and are no longer depreciated.
 
Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. In establishing the required allowance, we consider historical losses adjusted to take into account current market conditions and customers’ financial condition, the amount of receivables in dispute, and the current receivables aging and current payment patterns. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. We do not have any off-balance-sheet credit exposure related to its customers.

We extend unsecured credit to customers with good credit history. We review our accounts receivable on a regular basis to determine if the bad debt allowance is adequate at each year-end. We have not experienced any material write-offs in history.

Valuation of Inventories

Our inventories are stated at the lower of cost or net realizable value. We routinely evaluate quantities and value of our inventories in light of current market conditions and market trends, and record a write-down against the cost of inventories for a decline in net realizable value. Expected demand and anticipated sales price are the key factors affecting our inventory valuation analysis. For purposes of our inventory valuation analysis, we develop expected demand and anticipated sales prices primarily based on sales orders as well as industry trends and individual customer analysis. We also consider sales and sales orders after each reporting period-end but before the issuance of our financial statements to assess the accuracy of our inventory valuation estimates. Historically, actual demand and sales price have generally been consistent with or greater than expected demand and anticipated sales price used for purposes of the our inventory valuation analysis. The evaluation also takes into consideration new product development schedules, the effect that new products might have on the sale of existing products, product obsolescence, customer concentrations, product merchantability and other factors. Market conditions are subject to change and actual consumption of inventories could differ from forecasted demand. Furthermore, the price of plastic resins, our primary raw material, is subject to fluctuations based on global supply and demand. Our management continually monitors the changes in the purchase price paid for plastic resins, including advances to suppliers, and the impact of such change on our ability to recover the cost of inventory and our prepayments to suppliers. Our products have a long life cycle and obsolescence has not historically been a significant factor in the valuation of inventories. We have not experienced any material inventory write-downs before.
 

 40
 
 

 
Income Tax Uncertainties and Realization of Deferred Income Tax Assets

Our income tax provision, deferred income tax assets and deferred income tax liabilities are recognized and measured primarily based on actual and expected future income, PRC statutory income tax rates, PRC tax regulations and tax planning strategies. Significant judgment is required in interpreting tax regulations in the PRC, evaluating uncertain tax positions, and assessing the realizability of deferred income tax assets. Actual results could differ materially from those judgments, and changes in judgments could materially affect our consolidated financial statements. As of December 31, 2011 and 2010, we had total gross deferred income tax assets of US$1,005,361 and US$715,351, respectively. We record a valuation allowance to reduce our deferred income tax assets if, based on the weight of available evidence, we believe expected future taxable income is not likely to support the use of a deduction or credit in that jurisdiction. We evaluate the level of our valuation allowances quarterly, and more frequently if actual operating results differ significantly from forecasted results. As of December 31, 2011 and 2010, our valuation allowance against deferred income tax assets was US$1,005,361 and US$715,351, respectively. The change in valuation allowance was attributable primarily to deferred income tax assets, consisting primarily of tax losses carryforward of China XD Plastics and Favor Sea (US) which in our judgment, are not more likely than not to be realized as tax benefits in view of the cumulative loss positions of these entities.

We recognize the impact of a tax position if we determine the position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based solely on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, it is presumed that the position will be examined by the appropriate tax authority that has full knowledge of all relevant information. In addition, a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. The tax positions are regularly re-evaluated based on the results of the examination of income tax filings, statute of limitations expirations and changes in tax law that would either increase or decrease the technical merits of a position relative to the more-likely-than-not recognition threshold. In the normal course of business, we are regularly audited by the PRC tax authorities. The settlement of any particular issue with the applicable tax authority could have a material impact on our consolidated financial statements.

Stock Based Compensation
 
We measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award and recognize the cost over the period the employee is required to provide service in exchange for the award, which generally is the vesting period. We have elected to recognize the compensation cost for an award with only service conditions and a graded vesting schedule on a straight-line basis over the requisite service period for the entire award. However, the cumulative amount of compensation cost recognized at any date equals at least the portion of the grant date value of such award that is vested at that date.

We estimated the fair value of our share options using the Black-Scholes Option Pricing model. The model incorporates subjective assumptions. The expected volatility was based on implied volatilities from traded options, peer companies volatilities and historical volatility of the Company’s common stock. The risk free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. There is no expected dividend yield, as the Company has not paid dividend and does not anticipate paying dividend over the term of the grants.

Changes in our estimates and assumptions regarding the expected volatility could significantly impact the estimated fair values of our share options determined under the Black-Scholes valuation model and, as a result, our net income.
 

 41
 
 

 
Fair Value Measurements

We apply the provisions of ASC Subtopic 820-10, Fair Value Measurements, for fair value measurements of financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the financial statements.  The fair values are measured pursuant to the three levels defined as follow:

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

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

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

The fair values of the warrants outstanding as of December 31, 2011 and 2010 were determined based on the Black-Scholes option pricing model, using the following key assumptions:

   
Series A Investor Warrants
   
Series A Placement Agent Warrants
   
Series C Investor Warrants
   
Series C Placement Agent Warrants
 
   
December 31,
   
December 31,
   
December 31,
   
December 31,
 
   
2011
   
2010
   
2011
   
2010
      2011 *     2010       2011       2010  
Exercise price (per share)
    4.9       4.9       5.5       5.5       N/A       6.0       7.5       7.5  
Risk-free interest rate per annum
    0.4 %     1.5 %     0.4 %     1.5 %     N/A       0.3 %     0.2 %     0.8 %
Expected volatility
    72.0 %     69.2 %     72.0 %     69.2 %     N/A       47.2 %     55.4 %     78.0 %
Expected dividends yield
    0 %     0 %     0 %     0 %     N/A       0 %     0 %     0 %
Expected term
 
2.9 years
   
3.9 years
   
2.9 years
   
3.9 years
      N/A    
0.8 years
   
1.5 years
   
2.5 years
 
 
*Series C Investor Warrants expired on October 14, 2011
 
Results of Operations

The following table sets forth, for the periods indicated, statements of income data in thousands of USD:

 
For the Years Ended December 31,
(in thousands, except
 percentages)
2011
   
2010
 
  
Amount
   
%
   
Amount
   
%
 
Revenues
$
381,625
     
100
%
 
$
249,823
     
100
%
Cost of revenues
$
285,802
     
75
%
 
$
188,294
     
75
%
Gross profit
$
95,823
     
25
%
 
$
61,529
     
25
%
Total operating expenses
$
18,961
     
5
%
 
$
27,813
     
11
%
O Operating income
$
76,861
     
20
%
 
$
33,716
     
14
%
InIncome before income taxes
$
78,629
     
21
%
 
$
50,144
     
20
%
Income tax expenses
$
18,110
     
5
%
 
$
21,307
     
9
%
Net income
$
60,519
     
16
%
 
$
28,837
     
11
%
 
42
 
 

 
Revenues

Revenues were US$ 381.6 million, an increase of US$ 131.8 million, or 52.8%, as compared to US$ 249.8 million in 2010, due to approximately 33% increase in sales volume and 12.5% increase in the average selling price of our products on a constant dollar basis. The increase of sales volume was driven by the strong demand of modified plastics in the PRC market and higher penetration of our business in our existing markets supported by our newly acquired nine production lines in December 2010. The increase of average selling price was due to the shift of product mix towards higher-end products as well as higher raw material prices.

The following table summarizes the breakdown of revenues by categories in millions of US$:
 
     
Revenues
                 
(in millions, except  percentage)
   
For the Years Ended December 31,
                 
      2011        2010                  
     
Amount
     
%
     
Amount
     
%
     
Change in Amount
     
Change in %
 
Modified Polypropylene (PP)
    185.0       48.5 %     137.3       55.0 %     47.7       34.8 %
                                                 
Engineering Plastics
    70.9       18.6 %     40.5       16.2 %     30.4       74.9 %
                                                 
Modified Polyamide (PA)
    26.3       6.9 %     15.8       6.4 %     10.5       65.2 %
                                                 
Alloy Plastics
    28.3       7.4 %     12.7       5.1 %     15.6       124.0 %
                                                 
Environment Friendly Plastics
    32.6       8.5 %     10.8       4.3 %     21.8       201.4 %
                                                 
Modified Acrylonitrile Butadiene Styrene (ABS)
    20.3       5.3 %     14.6       5.8 %     5.7       39.2 %
                                                 
     Sub-total
    363.4       95.2 %     231.7       92.8 %     131.7       56.8 %
                                                 
After-sales service
    18.2       4.8 %     18.1       7.2 %     0.1       1.0 %
Total Revenues
    381.6       100 %     249.8       100 %     131.8       52.8 %

The following table summarizes the breakdown of metric tons (MT) by product mix:
 
     
Sales Volume
                 
(in MTs, except percentage)
      For the Years Ended December 31,                  
      2011         2010                  
     
MT
     
%
     
MT
     
%
     
Change in MT
     
Change in %
 
Modified Polypropylene (PP)
    99,052       65.5 %     83,523       73.4 %     15,529       18.6 %
                                                 
Engineering Plastics
    14,885       9.8 %     8,647       7.6 %     6,238       72.1 %
                                                 
Modified Polyamide (PA)
    6,167       4.1 %     4,106       3.6 %     2,061       50.2 %
                                                 
Alloy Plastics
    9,427       6.2 %     4,996       4.4 %     4,431       88.7 %
                                                 
Environment Friendly Plastics
    14,368       9.5 %     5,791       5.1 %     8,577       148.1 %
                                                 
Modified Acrylonitrile Butadiene Styrene (ABS)
    7,373       4.9 %     6,658       5.9 %     715       10.7 %
                                                 
Total sales volume
    151,271       100 %     113,721       100 %     37,550       33.0 %
 
The Company has shifted product mix from traditional Modified Polypropylene (PP) to higher-end products such as Environmental Friendly Plastics, Engineering Plastics and Alloy Plastics, primarily due to (i) the increasing demand of advanced modified plastics in luxury automobile models in China, (ii) the stronger demand promoted by Chinese government for clean energy vehicles and (iii) stronger sales of higher-end cars made by automotive manufacturers from China and Germany, US and Japanese joint ventures, which tend to use more and higher-end modified plastics in quantity per vehicle in China.
 

 43
 
 

 
Gross Profit and Gross Margin

   
For the Years Ended December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
Gross Profit
 
$
95.8
   
$
61.5
   
$
34.3
     
55.7
%
Gross Margin
   
25.1
   
24.6
           
0.5
%

Gross profit was US$ 95.8 million in 2011 compared to US$ 61.5 million in 2010, representing an increase of 55.7%. Our gross margin increased to 25.1% in 2011 from 24.6% in 2010. The increase was in line with the revenue growth, mainly attributed to the higher proportion of revenues of our high-end products as a percentage of total revenues in 2011 as a result of our efforts in developing and selling more high value-added automotive modified plastics. Such increase in demand was driven by increasing demand for automobiles by Chinese consumers, as well as the increase of plastic content on a per-vehicle-basis in China.


General and Administrative Expenses

   
For the Years Ended
December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
General and Administrative Expenses
 
$
7.1
   
$
19.9
   
$
(12.8
)
   
(64.6)
%
as a percentage of revenues
   
1.8
%
   
7.9
%
           
(6.1)
%

General and administrative (“G&A”) expenses were US$ 7.1 million in 2011 compared to US$19.9 million in 2010, representing a decrease of 64.6%, or US$ 12.8 million. This decrease is primarily due to the non-cash stock compensation expense of US$ 13.4 million in 2010 relating to options granted to Mr. Han, which was disclosed in our Current Report on Form 8-K on April 14, 2010 as well as in the footnote 15 in our consolidated financial statements.  There were no such grants in 2011.

On a percentage basis, G&A expenses in 2011 decreased to 1.8% of revenues from 7.9% in 2010.

Research and Development Expenses

   
For the Years Ended
December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
Research and Development Expenses
 
$
11.6
   
$
7.4
   
$
4.2
     
57.7
%
as a percentage of revenues
   
3.1
%
   
3.0
%
           
0.1
%

Research and development (“R&D”) expenses were US$ 11.6 million  in  2011 compared with US$ 7.4 million in 2010, an increase of US$ 4.2 million, or 57.7%, reflecting the increased research and development activities on new products in order to obtain product certifications for automotive applications from automobile manufacturers.
 
As of December 31, 2011, the number of ongoing research and development projects undertaken by us is 75. We expect completion and the resulting economic benefits approximately 29% of the projects in the near term. The remaining projects are expected to be carried out for a longer period. Majority of the projects are in the field of modified plastics in automotive applications and the rest are in advanced fields such as ships, airplanes etc.
 
44

 
 

 

Operating Income

Total operating income was US$ 76.8 million in 2011 compared to US$ 33.7 million in 2010, representing an increase of 128.0% or US$ 43.1 million. This increase is primarily due to higher gross profit and lower G&A expenses, partially offset by higher R&D expenses.

Interest Income (Expenses)
   
For the Years Ended
December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
Interest Income
 
$
0.7
   
$
-
   
$
0.7
     
N/A
 
Interest Expenses
   
(1.8
)
   
(1.3
)
   
(0.5
   
42.7
%
Net Interest Expenses
 
$
(1.1)
   
$
(1.3)
   
$
0.2
     
(9.7)
%
as a percentage of revenues
   
(0.3)
%
   
(0.5)
%
           
(0.2)
%

Net interest expenses remained stable in 2011 compared to that of 2010. On a percentage basis, net interest expenses in 2011 decreased to 0.3% of revenues from 0.5% in 2010.

Foreign Currency Exchange Gains (Losses)

   
For the Years Ended
December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
Foreign currency exchange gains (losses)
 
$
0.8
   
$
(0.1)
   
$
0.9
     
1,887.3
%
as a percentage of revenues
   
0.3
%
   
0
%
           
0.3
%

Foreign currency exchange gain (loss) was a gain of US$ 0.8 million in 2011, compared to a loss of US$49,047 in 2010.

Government Grant

   
For the Years Ended
December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
Government grant
 
$
0.2
   
$
3.2
   
$
(3.0)
     
(95.2)
%
as a percentage of revenues
   
0
%
   
1.3
%
           
(1.3)
%

Government grant was US$ 0.2 million in 2011, compared to US$3.2 million in 2010. The government grants in 2010 were subsidies granted by local government upon the completion of the business relocation and achievement of certain operating performance by Harbin Xinda in 2010.  There were no such grants in 2011.
 
Change in Fair Value of Warrants Liabilities

   
For the Years Ended
December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
Change  in fair value of warrants liabilities
 
$
1.9
   
$
6.3
   
$
(4.4)
     
(70.7)
%
as a percentage of revenues
   
0.5
%
   
2.5
%
           
(2.0)
%

Change in fair value of warrants liabilities was a gain of US$ 1.9 million in 2011, compared to a gain of US$6.3 million in 2010, primarily due to the change of fair value of warrants driven by the fluctuation of stock prices in the respective periods.   On a percentage basis, change in fair value of warrants liabilities in 2011 decreased to 0.5% of revenues from 2.5% in 2010.
 
45
 
 
 

 
Income Taxes

   
For the Years Ended
December 31,
   
Change
 
(in millions, except percentage)
 
2011
   
2010
   
Amount
   
%
 
Income before Income Taxes
 
$
78.6
   
$
50.1
   
$
28.5
     
56.8
%
Income Tax Expense
   
(18.1)
     
(21.3)
     
(3.2
)
   
(15.0)
%
Effective income tax rate
   
23.0%
     
42.5%
             
(19.5)
%


The effective income tax rate of 23.0% for the year ended December 31, 2011 differs from the PRC statutory income tax rate of 25% primarily due to (i) the preferential income tax rate of 15% entitled by Harbin Xinda, as an Advanced and New Technology Enterprise and (ii) the additional 50% bonus deduction against taxable income for the research and development expenses incurred by the Xinda Macromolecule Research Center and the Xinda Engineering Center.

Net Income

As a result of the above factors, we had a net income of US$ 60.5 million in 2011 compared to net income of US$ 28.8 million in 2010.


Selected Balance Sheet Data as of December 31, 2011 and 2010:
 
       Selected Balance Sheet Data  
     
2011
      2010      
Change
 
(in millions, except percentage)
                    Amount      
%
 
Cash and cash equivalents
   
135.5
     
22.7
     
112.8
     
496.3
%
Accounts receivable, net of allowance for doubtful accounts
   
45.2
     
29.0
     
16.2
     
55.9
%
Inventories
   
45.0
     
25.3
     
19.7
     
78.0
%
Property, plant and equipment, net
   
100.9
     
49.0
     
51.9
     
105.8
%
Total assets
   
360.6
     
159.4
     
201.2
     
126.2
%
Short-term bank loans
   
31.5
     
21.2
     
10.3
     
48.4
%
Bills payable
   
22.2
     
-
     
22.2
     
N/A
 
Income tax payable
   
5.8
     
0.1
     
5.7
     
8,735.1
%
Redeemable Series D convertible preferred stock
   
97.6
     
-
     
97.6
     
N/A
 
Stockholders' equity
   
173.9
     
104.3
     
69.6
     
66.7
%

Our financial condition continues to improve as measured by an increase of 66.7% in shareholders’ equity as of December 31, 2011 compared to December 31, 2010. Cash and cash equivalents increased by US$ 112.8 million, primarily due to US$ 100 million gross proceeds received from the issuance of redeemable Series D convertible preferred stock and the strong sales and cash collections. Accounts receivable increased by 55.9% as a result of growth of revenues.

46
 
 

 
LIQUIDITY AND CAPITAL RESOURCES

Historically, our primary uses of cash have been to finance working capital needs and capital expenditures for new production lines. We have financed these requirements primarily from cash generated from operations, short-term bank borrowings, and the issuance of our convertible preferred stock and other equity financings. As of December 31, 2011 and 2010, we had US$ 135.5 million and US$ 22.7 million, respectively, in cash and cash equivalents, which were primarily deposited with banks in China (including Hong Kong). As of December 31, 2011, we had US$ 31.5 million outstanding short-term bank loans, which bore a weighted average interest rate of 6.1% per annum. These loans were secured by (i) our property, plant and land use rights, (ii) equipments of Xinda High-Tech, and (iii) guaranteed by Mr. Han, our Chairman, and his wife.  These short-term bank loans have terms of no longer than one year and do not contain any renewal terms. We have historically been able to make repayments when due.  In addition, as of December 31, 2011, we have contractual obligations to pay (i) lease commitments in the amount of US$0.2 million; (ii) plant construction in the amount of US$50.4 million; (iii) warehouse construction in the amount of US$0.8 million; and (iv) equipment acquisition in the amount of US$0.3 million, all of which are due in 2012.

We expect that we will be able to meet our needs to fund operations, capital expenditures and other commitments in the next 12 months primarily with operating cash flows and bank borrowings. We may, however, require additional cash resources due to a change in business conditions or other future developments. If these sources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain credit facilities. The sale of additional equity or equity-linked securities could result in additional dilution to shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financial covenants that would restrict operations. Financing may not be available in amounts or on terms acceptable to us, or at all.

The following table sets forth a summary of our cash flows for the periods indicated.

   
For the Years Ended December 31,
 
(in millions US$)
 
2011
   
2010
 
       
Net cash provided by operating activities                                                                                             
    67.3       10.5  
Net cash used in  investing activities                                                                                             
    (62.4 )     (12.3 )
Net cash provided by financing activities                                                                                             
    105.6       17.4  
Effect of changes in exchange rate                                                                                             
    2.3       0.2  
Net increase in cash and cash equivalents                                                                                             
    112.8       15.8  
Cash and cash equivalents at the beginning of year                                                                                      
    22.7       6.9  
Cash and cash equivalents at the end of year                                                                                     
    135.5       22.7  

Operating Activities

Net cash provided by operating activities increased to US$ 67.3 million in 2011 from US$ 10.5 million in 2010, primarily due to (i) the increase of approximately US$ 138.8 million in cash collected from our customers during the year ended December 31, 2011 resulting from increased sales during the period and the stable Days Sales Outstanding (DSO) of our accounts receivable, which was partially offset by (i) an increase of approximately US$69.3 million cash payment in operating activities, including raw material purchases, rental and personnel costs during the year ended December 31, 2011; and (ii) an increase of approximately US$ 12.7 million in income taxes payments because we generated more taxable profit.

Investing Activities

Net cash used in investing activities was $62.4 million in 2011, primarily consisting of $62.5 million for the purchase of land use rights, plant and equipment.

Investing activities in 2010 consisted of (i) $0.3 million proceeds from disposal of equipment and (ii) $12.6 million for the purchase of property, plant and equipment.
 

47
 
 

 
Financing Activities

Net cash provided by the financing activities was $105.6 million in 2011, primarily as a result of $100 million and $30.6 million proceeds from issuance of Series D convertible preferred stock and bank loans, which were partially offset by our repayment of $21.6 million bank loan and $1.8 million interest free loan to a related party.

Net cash provided by the financing activities was $17.4 million in 2010, primarily as a result of $18.8 million and US$20.7 million proceeds from issuance of common stock and bank loans, respectively, which were partially offset by our dividend payment of $1.8 million to the holders of Series C preferred stock and our repayment of $21.9 million bank loans.

As of December 31, 2011, our cash and cash equivalents balance was US$135.5 million, compared to US$ 22.7 million at December 31, 2010.

Stable DSO has increased from 42 days for the year ended December 31, 2010 to 43 days for the year ended December 31, 2011.  We continued our policy on extending credit terms to credit worthy distributors that have long-standing business relationships with us in order to capture more market share.  The average DSO for the automotive modified plastic industry is generally 90 days based on our industry experience. The increased DSO was still below the industry average and reflected the normal fluctuation of our collections.

Industry Standard Customer and Supplier Payment Terms (days) as below:
 
  Year ended December 31, 2011 and 2010  
Customer Payment Term  Payment in advance/up to 90 days  
Supplier Payment Term Payment in advance/up to 30 days  
 
Inventory turnover days increased from 42 days for the year ended December 31, 2010 to 44 days for the year ended December 31, 2011, due to inventory buildup for Chinese New Year.

The Company is required to pay deposits to the suppliers for 50% to 90% of the amount of principal raw materials ordered. The Company makes advanced orders of raw materials based upon (1) the demand and supply situation in the raw materials market, and (2) the forecasted demand of products. All of the raw materials relating to advances to suppliers as of December 31, 2011 have been subsequently received by the Company in January 2012.

Based on past performance and current expectations, we believe our cash and cash equivalents and cash generated from operations will satisfy our working capital needs, capital expenditures and other liquidity requirements associated with our operations for at least the next 12 months.
 
All of the Company’s revenues and majority of its expenses were denominated in Renminbi (“RMB”), the currency of the PRC. There is no assurance that exchange rates between the RMB and the U.S. Dollar will remain stable. The Company does not engage in currency hedging. Inflation has not had a material impact on the Company’s business.

COMMITMENTS AND CONTINGENCIES

Contractual Obligations

Our contractual obligations at December 31, 2011 are as follows:

Contractual obligations
 
Total
   
Payment due 
less than 1 year
   
2 – 3 years
   
4-5 years
   
More than 5
years
 
Lease commitments
   
172,639
     
133,675
     
38,964
     
-
     
-
 
Plant construction
   
50,356,361
     
50,356,361
     
-
     
-
     
-
 
Warehouse construction
   
783,727
     
783,727
     
-
     
-
         
Equipment acquisition
   
348,817
     
348,817
     
-
     
-
     
-
 
Total
   
51,661,544
     
51,622,580
     
38,964
     
-
     
-
 

48
 
 

 
 
Off-Balance Sheet Arrangements
 
Neither us, nor any of our subsidiaries has any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on their financial condition or results of operations.
 
ITEM 7A.  
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Interest Rate Risk
 
We are exposed to interest rate risk primarily with respect to our short-term bank loans. Although the interest rates of our short-term bank loans, which are based on the prime rates set by People’s Bank of China, are fixed during the terms of the loans, increase in interest rates will increase the cost of new borrowings and our interest expense.
 
A hypothetical 1.0% increase in the annual interest rate for all of our credit facilities under which we had outstanding borrowings as of December 31, 2011 would decrease income before income taxes by approximately $0.08 million for the year ended December 31, 2011. Management monitors the banks' prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.
 
Foreign Currency Exchange Rates
 
All of our revenues are collected in and substantially all of our expenses are paid in RMB. We face foreign currency rate translation risks when our results are translated to U.S. dollars.
 
The RMB was relatively stable against the U.S. dollar at approximately 8.28 RMB to the $1.00 U.S. dollar until July 21, 2005 when the Chinese currency regime was altered resulting in a 2.1% revaluation versus the U.S. dollar. From July 21, 2005 to June 30, 2010, the RMB exchange rate was no longer linked to the U.S. dollar but rather to a basket of currencies with a 0.3% margin of fluctuation resulting in further appreciation of the RMB against the U.S. dollar. Since June 30, 2009, the exchange rate had remained stable at 6.8307 RMB to 1.00 U.S. dollar until June 30, 2010 when the Chinese Central Bank allowed a further appreciation of the RMB by 0.43% to 6.798 RMB to 1.00 U.S. dollar. On December 31, 2011, the RMB traded at 6.2939 RMB to 1.00 U.S. dollar.
 
There remains international pressure on the Chinese government to adopt an even more flexible currency policy and the exchange rate of RMB is subject to changes in China’s government policies which are, to a large extent, dependent on the economic and political development both internationally and locally and the demand and supply of RMB in the domestic market. There can be no assurance that such exchange rate will continue to remain stable in the future amongst the volatility of currencies, globalization and the unstable economies in recent years. Since (i) our revenues and net income of our PRC operating entities are denominated in RMB, and (ii) the payment of dividends, if any, will be in U.S. dollars, any decrease in the value of RMB against U.S. dollars would adversely affect the value of the shares and dividends payable to shareholders, in U.S. dollars.
 
49
 
 

 
ITEM 8.  
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The consolidated financial statements of the Company and its subsidiaries as of and for the years ended December 31, 2011 and 2010, including the notes thereto, together with the reports of our independent registered public accounting firms, are presented beginning on page F-1 of this report and are incorporated into this Item 8.
 
 ITEM 9.  
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
 None.
 
 ITEM 9A.
CONTROLS AND PROCEDURES
 
 (a)           Evaluation of Disclosure Controls and Procedures
 
We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time period specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
The Company’s management has evaluated, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-15(e)), as of the end of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of December 31, 2011, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures was completed, because of the material weakness in our internal control over financial reporting described below, our disclosure controls and procedures were not effective to satisfy the objectives for which they are intended.
 
Notwithstanding management’s assessment that our internal control over financial reporting was ineffective as of December 31, 2011 due to the material weakness described below under Management’s Report on Internal Control Over Financial Reporting, we believe that the consolidated financial statements included in this Annual Report on Form 10-K correctly present our financial condition, results of operations and cash flows for the fiscal years covered thereby in all material respects.
 
(b)           Management’s Annual Report on Internal Control over Financial Reporting
 
The Company’s management is responsible for establishing and maintaining an adequate system of internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
50
 
 

 
The Company’s management, including the Company’s principal executive officer and principal financial officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on this assessment, management believes that, as of December 31, 2011, the Company’s internal control over financial reporting was ineffective. This assessment identified a material weakness related to insufficient competent accounting personnel in applying U.S. generally accepted accounting principles,  in particular, accounting for Series D preferred stock and application of two class method in the calculation of earnings per share. This assessment also identified a significant deficiency related to lack of tax expertise to review the income taxes of the entities in the People’s Republic of China (the “PRC”) and the United States of America (the “USA”). The Company will recruit qualified accounting personnel with sufficient understanding, experience and training in U.S. GAAP and continue engaging qualified entities to arrange training for financial and accounting personnel on a periodic basis to so that they could have adequate knowledge about U.S. GAAP and qualified tax expert to review the Company’s tax position in entities in the PRC and the USA.

Management’s report is not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report.
 
(c)   Changes in Internal Control over Financial Reporting
 
There were no changes in its internal controls over financial reporting in the fourth quarter of 2011 that would materially affect, or are reasonably likely to materially affect our internal control over financial reporting.
 
 ITEM 9B.
OTHER INFORMATION
 
 None.
 
51
 
 

 
PART III
 
 ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
 Directors and Executive Officers
 
The following table sets forth the names and ages of our current directors and executive officers, their age, their principal offices and positions and the date each such person became a director or executive officer. Executive officers are appointed at the discretion of the Board of Directors. Directors are elected annually by our stockholders at our annual meeting of stockholders. Each director holds his office until his successor is elected and qualified or his earlier resignation or removal.
 
Our current directors and executive officers are as follows:
 
Name
Age
Title
Date of Initial Appointment
Jie Han
46
Chief Executive Officer and Chairman of the Board of Directors
December 31, 2008
Taylor Zhang
33
Chief Financial Officer and Director
May 14, 2009
Qingwei Ma
37
Chief Operating Officer and Director
December 31, 2008
Lawrence W. Leighton (1)(2)(3)
77
Independent Director
May 14, 2009
Robert Brisotti (1)(2)(3)
65
Independent Director
October 4, 2010
Linyuan Zhai (1)(2)(3)
62
Independent Director
May 14, 2009
Homer Sun (2)(4)
40
Independent Director
January 1, 2012
Jun Xu(4)
36
Independent Director
September 28, 2011
Junjie Ma
36
Chief Technology Officer
May 26, 2009
 
(1)  Serves as a member of the Audit Committee.
 
(2)  Serves as a member of the Compensation Committee.
 
(3)  Serves as a member of the Nominating Committee.
 
(4)  Series D Director nominee.
 
Jie Han. Mr. Han co-founded Harbin Xinda, the Company’s wholly owned subsidiary, in 2004, and has been employed by Harbin Xinda and then Xinda Group since then. In January 2008, Mr. Han was appointed Chairman and Chief Executive Officer of Harbin Xinda. Prior to organizing Xinda High-Tech, which was founded in 2003, Mr. Han had been associated with the Harbin Xinda Nylon Factory, which he founded in 1985. With 27 years of experiences in the industry, Mr. Jie Han is an expert in the management and financial aspects of the manufacture and distribution of modified plastic products. Mr. Han currently serves as an executive director of China Plastic Processing Industry Association and is also a director of the Heilongjiang Industry and Commerce Association. In addition, Mr. Han serves as a deputy to the Heilongjiang Provincial People's Congress. Mr. Han received a business management degree from the Heilongjiang Provincial Party School.
 
52
 
 

 
Taylor Zhang. Mr. Zhang has over nine years of experience in finance and operation in a broad range of industries. From May 2008 to March 2009, Mr. Zhang served as Chief Financial Officer of Advanced Battery Technologies, Inc (NASDAQ: ABAT). From 2007 to 2008, he served as Executive Vice President of Finance of China Natural Gas, Inc. (NASDAQ: CHNG). From 2005 to 2007, Mr. Zhang worked as a research analyst in New York Private Equity. From 2000 to 2002, he was employed as Finance Manager by Datong Thermal Power Limited. He holds a MBA from University of Florida and a Bachelor’s Degree in mechanical and electronic engineering from Beijing Technology and Business University.
 
Qingwei Ma. Mr. Ma was employed as the General Manager of Harbin Xinda since it was founded in 2004. In 2008, he was promoted to Chief Operating Officer and appointed to the Board of Directors. Prior to joining Harbin Xinda, Mr. Ma was employed for six years by Harbin Xinda Nylon Factory as Manager of Quality Assurance, then as Manager of Research and Development, and finally as Production Manager. In 1997, Mr. Ma was awarded a bachelor’s degree by the Northern China Technology University, where he specialized in the chemical engineering of high polymers. Mr. Ma has 14 years of experiences in the industry. He also published two articles in China’s key journals in the areas of modified plastic industry. In 2001, Mr. Ma was selected as “Harbin Quality Work Advanced Enterprise and Advanced Worker”; in 2004, he was awarded the Heilongjiang First Professional Manager Qualification Certificate. One of his inventions, “compound nano modified materials dedicated to the automobile bumper,” won the “Science and Technology Progress Awards” issued by Harbin Municipality.
 
Junjie Ma. Mr. Ma graduated from Beijing University of Science and Technology, majored in Polymer materials and engineering. He was appointed acting Chief Technology Officer of China XD in 2009.  From December 2008 to May 2009, Mr. Ma served as a member of our Board of Directors. He was a technician of Harbin Longjiang Electrical Plant from 1997 to 2004 and was a supervisor and manager of Harbin Xinda Macromolecule Material Inc. from 2004 to 2007. Since 2008, he was elected to be Head of Research Institute of Harbin Xinda Macromolecule Material Co., Ltd. Mr. Junjie Ma is a polymer materials engineers and has developed more than 120 plastic additives, modified plastics for automobiles and engineering plastics among which 50 products have been approved by auto enterprises. A number of products have been awarded as the National Torch Program projects, Spark Projects and Harbin City Important New Products project.
 
Lawrence W. Leighton. Mr. Leighton has had an extensive 45-year international investment banking career. Beginning at what became Lehman Brothers, he advised on financing for the Mexican Government and leading Mexican corporations. As Director of Strategic Planning for the consumer products company, Norton Simon Inc., he initiated and executed the acquisition of Avis Rent-a-car. Subsequently, he was a Limited Partner of Bear Stearns & Co., a Managing Director of the investment bank of Chase Manhattan Bank and then President and Chief Executive Officer of the U.S. investment bank of Credit Agricole, a major French Bank. Among his transactions have been advising Pernod Ricard, a major European beverage company, on its acquisitions in the United States; and advising Verizon, a U. S. telecom company, on its dispositions of certain European operations. Since 2005, Mr. Leighton has served as a managing director of Bentley Associates Investment Banking.  Since 2008, Mr. Leighton has served as a member of the Board of Directors of China Natural Gas, Inc. Mr. Leighton received his Bachelor’s Degree in engineering from Princeton University and a Master’s Degree from Harvard Business School. He holds a commercial pilot’s license with instrument rating.
 
53
 
 

 
Robert Brisotti. Mr. Brisotti has 20 years of experience in the securities industry as an investment banker and securities analyst and 14 years of experience in the plastics industry as a business manager and chemist. Since June 2010, Mr. Brisotti has served as a Senior Vice President at Buckman, Buckman & Reid, Inc., where he manages underwriting and merger and acquisition transactions. From August 2008 to June 2010, Mr. Brisotti was a Senior Vice President at Mercer Capital Ltd. From February 2007 to August 2008, Mr. Brisotti was a Senior Vice President at Andrew Garrett, Inc.  From July 2004 to February 2007, he was a Senior Vice President at S. W. Bach & Co. In the plastics industry, Mr. Brisotti has experience with acrylics at Rohm and Haas, urethanes at Olin Corporation and polyolefins at Union Carbide. Mr. Brisotti has a BS in Chemistry from Lehigh University, a MS in Chemistry from the University of Rhode Island, and a MBA in Finance from Columbia University.
 
Linyuan Zhai.  Mr. Zhai worked for China FAW Group Corporation for 37 years and has abundant experience in terms of technology, production, and business management. He is one of the pioneers and outstanding contributors of FAW Group’s success. Since 2000, Mr. Zhai has served as general manager of FAW Sihuan Products Co., Ltd., an automobile manufacturing company. From August 1998 to December 2000, Mr. Zhai was the manufacturing section chief at FAW Sihuan Head Office.  From August 1992 to August 1998, Mr. Zhai was the factory manager at FAW Sihuan Auto Warm Air Blower Factory. In 2000, as deputy general manager, successfully led the initial public offering of Four Ring Company, a subsidiary of FAW Group, a leader in the vehicle manufacturing industry based in China. Mr. Zhai received his business management degree from Changchun University.
 
Homer Sun. Mr. Sun, 40, is a Managing Director of Morgan Stanley and leads Morgan Stanley Private Equity Asia’s China Investments.  Mr. Sun has been at Morgan Stanley since 1999 and serves on Morgan Stanley’s China Management Committee, which is comprised of the Morgan Stanley’s senior business leaders within China.  Mr. Sun currently serves as a director on the boards of several Chinese companies, including Sihuan Pharmaceutical Group, China Shanshui Cement Group, China Flooring and Yongye International.  From 2000 to 2006, Mr. Sun worked in Morgan Stanley’s Investment Banking Division in the Mergers and Acquisitions Group in Hong Kong where he worked on a wide range of mergers and acquisitions in Greater China.  Prior to joining Morgan Stanley, Mr. Sun practiced as a mergers and acquisitions lawyer with the law firm Simpson Thacher & Bartlett in New York and Hong Kong from 1996 to 2000.  Mr. Sun received a B.S.E. in Chemical Engineering magna cum laude from the University of Michigan and a J.D. cum laude from the University of Michigan Law School.
 
Jun Xu. Mr. Xu is an Executive Director of Morgan Stanley. Mr. Xu joined Morgan Stanley Private Equity Asia in 2008 after spending six years in investment banking advising Chinese clients on financing transactions and cross-border mergers and acquisitions. Prior to joining Morgan Stanley in 2005, he was with Goldman Sachs in Hong Kong SAR from 2002 to 2005. Mr. Xu focuses on the group's private equity transactions in China. Mr. Xu received dual Bachelor Degrees in both international trade and computer science magna cum laude from Shanghai Jiaotong University and an M.B.A. with honours from the University of Michigan.
 
Mr. Yong Jin served as a member of the Board of Directors from May 14, 2009 to December 31, 2011. On December 31, 2011, he resigned from the Board of Directors. There were no disagreements between Mr. Jin and the Company on any matter relating to the Company's operations, policies or practices.
 
Mr. Eddy Huang served as a member of the Board of Directors from September 28, 2011 to December 31, 2011.  On January 1, 2012, he resigned from the Board of Directors. There were no disagreements between Mr. Huang and the Company on any matter relating to the Company’s operations, policies or practices.
 
54
 
 

 
Family Relationships
 
There are no family relationships between or among any of the executive officers or directors of the Company.
 
Board Leadership Structure
 
The Board of Directors believes that Jie Han’s service as both Chairman of the Board of Directors and Chief Executive Officer is in the best interest of the Company and its stockholders. Mr. Han possesses detailed and in-depth knowledge of the issues, opportunities, and challenges facing the Company, and is thus best positioned to develop agendas that ensure that the time and attention of our Board of Directors are focused on the most critical matters. His combined role enables decisive leadership, ensures clear accountability, and enhances the Company’s ability to communicate its message and strategy clearly and consistently to the Company’s stockholders, employees and customers.
 
Each of the directors other than Jie Han, Taylor Zhang and Qingwei Ma is independent (see “Director Independence” below), and the Board of Directors believes that the independent directors provide effective oversight of management. The Board of Directors has not designated a lead director.  Our independent directors call and plan their executive sessions collaboratively and, between Board of Directors meetings, communicate with management and one another directly.  In the circumstances, the directors believe that formalizing in a lead director functions in which they all participate might detract from rather than enhance performance of their responsibilities as directors.
 
Director Qualifications
 
We seek directors with established strong professional reputations and experience in areas relevant to the strategy and operations of our businesses.  We also seek directors who possess the qualities of integrity and candor, who have strong analytical skills and who are willing to engage management and each other in a constructive and collaborative fashion, in addition to the ability and commitment to devote significant time and energy to service on the Board of Directors and its committees.  We believe that all of our directors meet the foregoing qualifications.
 
The Nominating Committee and the Board of Directors believe that the leadership skills and other experiences of its Board of Directors members, as described below, provide the Company with a range of perspectives and judgment necessary to guide our strategies and monitor their execution.
 
Jie Han: Mr. Han is the founder of China XD and of our former affiliate, Harbin Xinda Nylon Factory.  He has over 27 years of experience in the modified plastics industry.  Mr. Han contributed to our Board of Directors strong leadership and vision for the development of our Company.  Mr. Han also serves as an executive director of China Plastic Processing Industry Association and he is a member of Industry and Commercial Union Executive Committee of Heilongjiang Province. Mr. Han is a director of the Chinese Chamber of Commerce and People’s Congress Representative of Harbin City.  Mr. Han is an expert in all management and financial aspects of manufacture and distribution of modified plastic products.
 
Taylor Zhang: Mr. Zhang has over nine years of experience in finance and operations in a broad range of industries.  He was the former Chief Financial Officer of Advanced Battery Technologies, Inc. (NASDAQ: ABAT) and has a MBA from University of Florida.
 
55
 
 

 
Qingwei Ma: Mr. Ma served as the Company’s Chief Operating Officer since 2008. Mr. Ma has over 14 years of experience in the modified plastics industry. Prior to joining China XD, has was a member of the senior management team of Harbin Xinda Nylon Factory and was awarded the Heilongjiang First Professional Manager Qualification Certificate in 2004.
 
Lawrence W. Leighton: Mr. Leighton has over 45 years of experience as an investment banker and corporate executive advising both large and small corporations in both foreign countries and the United States.
 
Robert Brisotti: Mr. Brisotti has over 20 years of experience in the securities industry as an investment banker and securities analyst and 14 years of experience in the plastics industry as a business manager and chemist.
 
Linyuan Zhai: Mr. Zhai contributes to our Board of Directors extensive experience in the areas of auto technology, production, and business management, which he accumulated while working for China FAW Group Corporation during his 38 years of employment.
 
Homer Sun: Mr. Sun contributes to our Board of Directors a broad range of transactional experience, both as a practicing lawyer and as a managing director at Morgan Stanley. Mr. Sun received a J.D. with honours from the University of Michigan Law School.
 
Jun Xu: Mr. Xu contributes to our Board of Directors extensive experience in cross-border M&A transactions and private equity transactions. Mr. Xu received an M.B.A. with honours from the University of Michigan.
 
Board of Directors Practices
 
Our business and affairs are managed under the direction of our Board of Directors. The primary responsibilities of our Board of Directors are to provide oversight, strategic guidance, counseling and direction to our management. It is our expectation that the Board of Directors will meet regularly on a quarterly basis and additionally as required.
 
Board of Directors’ Role in Risk Oversight
 
The Board of Directors as a whole has responsibility for risk oversight, with reviews of certain areas being conducted by the relevant Board of Directors committees. These committees then provide reports to the full Board of Directors.  The oversight responsibility of the Board of Directors and its committees is enabled by management reporting processes that are designed to provide visibility to the Board of Directors about the identification, assessment, and management of critical risks.  These areas of focus include strategic, operational, financial and reporting, succession and compensation, compliance, and other risks.  The Board of Directors and its committees oversee risks associated with their respective areas of responsibility, as summarized below.
 
Meetings of the Board of Directors
 
The Board of Directors held 10 meetings during 2011. No director attended fewer than 75% of the meetings of the Board of Directors which were held after the director was elected to the Board. No director attended less than 75% of any meeting of a committee of which the director was a member in fiscal year 2011.
 
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Involvement in Certain Legal Proceedings
 
None of our directors and officers has been involved in any of the legal proceedings specified in Item 401(f) of Regulation S-K in the past 10 years.
 
Committees of the Board of Directors
 
Our Board of Directors has an Audit Committee, a Nominating Committee, and a Compensation Committee. Our Board of Directors has determined that Lawrence W. Leighton, Robert Brisotti, Linyuan Zhai  and Homer Sun, the members of these committees, are “independent” under the current independence standards of NASDAQ Marketplace Rule 4200(a)(15) and meet the criteria for independence set forth in Rule 10A-3(b)(1) under the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our Board of Directors has also determined that these persons have no material relationships with us — either directly or as a partner, stockholder or officer of any entity — which could be inconsistent with a finding of their independence as members of our Board of Directors.
 
Audit Committee
 
The Audit Committee was established on May 26, 2009.  The Audit Committee operates under a written charter.  The Audit Committee Charter can be found on our website at www.chinaxd.net and can be made available in print free of charge to any shareholder who requests it..
 
The Audit Committee’s charter states that the responsibilities of the Audit Committee shall include, among other things:
 
 ●
reviewing the Audit Committee’s charter, annual report to stockholders and reports submitted to the SEC;
 ●
appointing the Company’s independent auditors, confirming and reviewing their independence, and approving their fees;
 ●
reviewing the independent auditors’ performance;
 ●
discussing with the independent auditor and management the independent auditor’s judgment about the quality, not just the acceptability, of the Company’s accounting principles;
 ●
following an audit, reviewing significant difficulties encountered during the audit; and
 ●
reviewing significant disagreements among management and the independent auditors in the preparation of the Company’s financial statements.
 
In addition, the Audit Committee reviews and approves all transactions with affiliates, related parties, directors and executive officers.
 
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The Audit Committee held nine meetings during 2011. The members of the Audit Committee during 2011 were Lawrence Leighton, Robert Brisotti, and Linyuan Zhai.  Mr. Leighton served as the Chairman of the Audit Committee. Each of the above-listed Audit Committee members were or are considered “independent” under the current independence standards of NASDAQ Marketplace Rule 4200(a)(15) and meet the criteria for independence set forth in Rule 10A-3(b)(1) of the Securities Exchange Act of 1934, as amended, as determined by the Board of Directors.
 
Our Board of Directors has determined that we have at least one audit committee financial expert, as defined in the Exchange Act, serving on our Audit Committee. Lawrence Leighton is the “audit committee financial expert” and is an independent member of our Board of Directors.
 
AUDIT COMMITTEE REPORT
 
The following is the report of the Audit Committee of the Board of Directors. The Audit Committee has reviewed and discussed our audited financial statements for the fiscal year ended December 31, 2011 with our management. In addition, the Audit Committee has discussed with KPMG, our independent auditors, the matters required to be discussed by Statement on Auditing Standards No. 61, as amended (Communications with Audit Committees). The Audit Committee also has received the written disclosures and the letter from KPMG as required by the Public Company Accounting Oversight Board Rule 3526 “Communications with Audit Committees Concerning Independence” and the Audit Committee has discussed the independence of KPMG with that firm. 
 
Based on the Audit Committee’s review of the matters noted above and its discussions with our independent auditors and our management, the Audit Committee recommended to the Board of Directors that the financial statements be included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
 
Respectfully submitted by:
 
Lawrence Leighton (Chair)
 
Robert Brisotti
 
Linyuan Zhai
 
Nominating Committee
 
The Nominating Committee was established on May 26, 2009.  The purpose of the Nominating Committee is to assist the Board of Directors in identifying qualified individuals to become members of the Board of Directors, in making recommendations to the Board of Directors as to the independence of each director, in monitoring significant developments in the law and practice of corporate governance and of the duties and responsibilities of directors of public companies, and in leading the Board of Directors in any annual performance self-evaluation, including establishing criteria to be used in connection with such evaluation.  The Nominating Committee held one meeting during 2011.
 
58
 
 

 
The members of the Nominating Committee during 2011 were Lawrence Leighton, Robert Brisotti and Linyuan Zhai. Mr. Zhai served as the Chairman of the Nominating Committee.  Mr. Brisotti joined the Nominating Committee in October 2010 following Mr. Patti’s resignation from and his appointment to the Board of Directors. Mr. Jin resigned from the Nominating Committee on December 31, 2011. Each of the above-listed Nominating Committee members were or are considered “independent” under the current independence standards of NASDAQ Marketplace Rule 4200(a)(15) and meet the criteria for independence set forth in Rule 10A-3(b)(1) of the Securities Exchange Act of 1934, as amended, as determined by the Board of Directors.
 
The Nominating Committee operates under a written charter. The Nominating Committee Charter can be found on our website at www.chinaxd.net and can be made available in print free of charge to any shareholder who requests it.
 
On September 28, 2011 the Company filed a Certificate of Designation with the Secretary of State of the State of Nevada, which provides the holders of the Series D Preferred Stock with the right to elect up to two (2) directors to the Company’s Board of Directors on the terms and conditions set forth therein.  There have been no other changes to the procedures by which the stockholders of the Company may recommend nominees to the Board of Directors since the filing of the Company’s Definitive Proxy Statement on November 19, 2009 for its Annual Meeting of Stockholders, which was held on December 1, 2009.  The Nominating Committee will consider director candidates recommended by any reasonable source, including current Board of Directors members, stockholders, professional search firms or other persons.  The directors will not evaluate candidates differently based on who has made the recommendation.  The Board of Directors does not have a formal policy on Board of Directors candidate qualifications.  The Board of Directors may consider those factors it deems appropriate in evaluating director nominees made either by the Board of Directors or stockholders, including judgment, skill, strength of character, experience with businesses and organizations comparable in size or scope to the Company, experience and skill relative to other Board of Directors members, and specialized knowledge or experience in business or financial matters as would make such nominee an asset to the Board of Directors and may, under certain circumstances, be required to be “independent,” as such term is defined in the NASDAQ Marketplace Rules and applicable SEC regulations.  Depending upon the current needs of the Board of Directors, certain factors may be weighed more or less heavily.  In considering candidates for the Board of Directors, the directors evaluate the entirety of each candidate’s credentials and do not have any specific minimum qualifications that must be met.
 
Security holders wishing to submit the name of a person as a potential nominee to the Board of Directors must send the name, address, and a brief (no more than 500 words) biographical description of such potential nominee to the Nominating Committee at the following address: Nominating Committee of the Board of Directors, c/o China XD Plastics Company Limited, 500 Fifth Ave Suite 4120, New York, NY 10110.  Potential director nominees will be evaluated by personal interview, such interview to be conducted by one or more members of the Nominating Committee, and/or any other method the Nominating Committee deems appropriate, which may, but need not, include a questionnaire.  The Nominating Committee may solicit or receive information concerning potential nominees from any source it deems appropriate.  The Nominating Committee need not engage in an evaluation process unless (i) there is a vacancy on the Board of Directors, (ii) a director is not standing for re-election, or (iii) the Nominating Committee does not intend to recommend the nomination of a sitting director for re-election.  A potential director nominee recommended by a security holder will not be evaluated any differently than any other potential nominee.  Although it has not done so in the past, the Nominating Committee may retain search firms to assist in identifying suitable director candidates.
 
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Compensation Committee
 
The Compensation Committee was established on May 26, 2009. The members of the Compensation Committee during 2011 were Lawrence Leighton, Robert Brisotti and Linyuan Zhai. On September 28, 2011, Eddy Huang was elected as a member of the Compensation Committee and following his resignation from the Board of Directors on January 1, 2012 and Homer Sun was elected as a member of the Compensation Committee on January 1, 2012. Mr. Brisotti served as the Chairman of the Compensation Committee.
 
Each of these members were or are considered “independent” under the current independence standards of NASDAQ Marketplace Rule 4200(a)(15) and meet the criteria for independence set forth in Rule 10A-3(b)(1) of the Securities Exchange Act of 1934, as amended, as determined by the Board of Directors. The Compensation Committee operates under a written charter.  The Compensation Committee Charter can be found on our website at www.chinaxd.net and can be made available in print free of charge to any shareholder who requests it.
 
The Compensation Committee discharges the Board of Directors’ responsibilities relating to compensation of the Company’s executive officers and administers our 2010 Stock Incentive Plan. The Committee has overall responsibility for approving and evaluating the executive officer compensation plans, policies and programs of the Company. The Compensation Committee held six meetings during 2011.
 
Code of Business Conduct
 
We have adopted a code of business conduct that applies to our directors, officers and employees. A written copy of the code can be found on our website at www.chinaxd.net and can be made available in print to any shareholder upon request at no charge by writing to our Secretary, c/o China XD Plastics Company Limited, 500 Fifth Ave Suite 4120, New York, NY 10110.  Our code of business conduct is intended to be a codification of the business and ethical principles which guide us, and to deter wrongdoing, to promote honest and ethical conduct, to avoid conflicts of interest, and to foster full, fair, accurate, timely and understandable disclosures, compliance with applicable governmental laws, rules and regulations, the prompt internal reporting of violations and accountability for adherence to the code.
 
Executive Sessions
 
Under NASDAQ Marketplace Rule 5605(b)(2), our independent directors are required to hold regular executive sessions. The chairperson of the executive session will rotate at each session so that each non-management director shall have an opportunity to serve as chairperson. Interested parties may communicate directly with the presiding director of the executive session or with the non-management directors as a group, by directing such written communication to Mr. Lawrence Leighton at c/o China XD Plastics Company Limited, 500 Fifth Ave Suite 4120, New York, NY 10110.
 
Process for Sending Communications to the Board of Directors
 
The Board of Directors maintains a process for stockholders to communicate with the Board of Directors.  Stockholders wishing to communicate with the Board of Directors or any individual director may send an email through our website at www.chinaxd.net or mail a communication addressed to the Secretary of the Company, c/o China XD Plastics Company Limited, 500 Fifth Ave Suite 4120, New York, NY 10110.  Any such communication must state the number of shares of common stock beneficially owned by the stockholder making the communication.  All of such communications will be forwarded to the full Board of Directors or to any individual director or directors to whom communication is directed unless the communication is clearly of a marketing nature or is inappropriate, in which case we have the authority to discard the communication or take appropriate legal action regarding the communication.
 
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Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the executive officers and directors of the Company and every person who is directly or indirectly the beneficial owner of more than 10% of any class of security of the Company to file reports of ownership and changes in ownership with the Securities and Exchange Commission.  Such persons also are required to furnish our company with copies of all Section 16(a) forms they file.  Based solely on our review of copies of such forms received by us, we believe that during the fiscal year 2011, all of the executive officers and directors of the Company and every person who is directly or indirectly the beneficial owner of more than 10% of any class of security of the Company complied with the filing requirements of Section 16(a) of the Exchange Act.
 
 ITEM 11.  
EXECUTIVE COMPENSATION
 
In 2011, pursuant to  the Company’s 2010 Executive Compensation Program which set forth cash and stock compensation of the Company’s executives and directors, including the Company’s named executive officers, the executive  officers is entitled to receive the compensation as follows:
 
Compensation for Mr. Jie Han, the Company’s Chief Executive Officer: For the fiscal year 2011, Mr. Han is entitled to a base salary of $46,766 (RMB 302,220). In addition, Mr. Han may receive a discretionary bonus as determined by the Compensation Committee of the Board of Directors at the end of the fiscal year.
 
Compensation for Mr. Taylor Zhang, the Company’s Chief Financial Officer:  For the fiscal year 2011, Mr. Zhang is entitled to a base salary of $129,436. On August 7, 2010, Mr. Zhang received options to purchase up to 100,000 shares of the Company’s common stock at the exercise price of $8.01 per shares and 14,000 non-vested shares under our 2009 Stock Option / Stock Issuance Plan. One-third of the stock options shall vest on the every anniversary of the grant date over a three year period. The restricted shares shall vest on the third anniversary of the grant date. In addition, Mr. Zhang may receive a discretionary bonus as determined by the Compensation Committee of the Board of Directors at the end of the fiscal year.
 
Compensation for Mr. Qingwei Ma, the Company’s Chief Operating Officer:  For the fiscal year 2011, Mr. Ma is entitled to a base salary of $32,459 (RMB 209,760). On August 7, 2010, Mr. Ma’s was granted options to purchase up to 75,000 shares of the Company’s common stock at the exercise price of $8.01 per share and 12,000 nonvested shares under our 2009 Stock Option / Stock Issuance Plan. One-third of the stock options shall vest on the every anniversary of the grant date over a three year period. The restricted shares shall vest on the third anniversary of the grant date. In addition, Mr. Ma may receive a discretionary bonus as determined by the Compensation Committee of the Board of Directors at the end of the fiscal year.
 
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The following table is a summary of the compensation paid to our executive officers for the two years ended December 31, 2011and 2010.
 
SUMMARY COMPENSATION TABLE
 
Name and Principal Position
Year
 
Salary ($)
   
Bonus ($)
   
Stock
Awards
($)(3)
   
Option Awards
($)
   
Non-Equity Incentive Plan Compen-
sation
($)
   
Change in Pension Value and Nonqualified Deferred Compensation Earnings
($)
   
All Other Compens-
ation
($)
 
Total
($)
                                               
Jie Han,
2011
 
61,622
   
-
   
-
   
-
   
-
   
-
   
-
 
 61,622
CEO
2010
 
35,460
   
-
   
-
   
13,355,832
(2)
 
-
   
-
   
-
 
 13,391,292
                                               
Qingwei Ma,
2011
 
64,249
   
-
   
26,280
   
56,000
(3)
 
-
   
-
   
-
 
 146,529
COO
2010
 
15,918
   
-
   
10,512
   
22,400
   
-
   
-
   
-
 
 48,830
                                               
Taylor Zhang,
2011
 
129,436
   
-
   
30,660
   
74,667
(3)
 
-
   
-
   
-
 
 234,763
CFO (1)
2010
 
124,474
   
-
   
12,264
   
29,867
   
-
   
-
   
-
 
 166,605
 
 (1) 
Mr. Zhang was appointed as our CFO on May 1, 2009.
 
 (2) 
The options were issued pursuant to an Incentive Option Agreement dated May 16, 2008 between Ms. Piao and Mr. Han pursuant to which Ms. Piao granted Mr. Han 40,000 options to purchase all the shares of XD Engineering Plastics, the controlling shareholder of the Company, subject to the Company achieving certain financial performance targets, which the Company accounted for as share-based compensation awarded to an employee by a related party in accordance to ASC Topic 718.
 
 (3) 
Stock awards granted to Mr. Ma and Mr. Zhang will vest on August 7, 2013 and represent the amount of stock compensation expense recognized in 2011 in accordance with FASB ASC 718.
 
The following is a summary of all options, unvested stock and equity incentive plans for our executive officers for the year ended December 31, 2011.
 
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OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
 
   
Option Awards
   
Stock Awards
 
Name
 
Name of securities underlying unexercised options (#) exercisable
   
Number of securities underlying unexercised options (#) unexercisable
   
Equity incentive plan awards: Number of securities underlying unexercised unearned options (#)
   
Option exercise price ($)
   
Option expiration date
   
Number of shares or units of stock that have not vested (#)
   
Grant date fair value of stock or units of stock that have not vested ($)
   
Equity incentive plan awards: Number of unearned shares, units or other rights that have not vested (#)
   
Equity incentive plan awards: Market or payout value of unearned shares, units or other rights that have not vested ($)
 
Jie Han, CEO
   
0
     
-
     
-
     
-
  </