10-Q 1 cxdc_10q-093012.htm FORM 10-Q FOR THE PERIOD ENDED 9-30-12 cxdc_10q-093012.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____ to _____
 
Commission File Number:  000-53131

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, PRC 150060
(Address of principal executive offices) (Zip Code)

86-451-84346600
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  
Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o
Accelerated filer  o
Non-accelerated filer  o   
(Do not check if a smaller reporting company)
Smaller reporting company  x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of November 12, 2012, the registrant had 47,563,772 shares of common stock, par value US$0.0001 per share, outstanding.

 
 
 

 
TABLE OF CONTENTS
 
PAGE
PART I. FINANCIAL INFORMATION
 
     
Item 1. Financial Statements
2
     
 
Unaudited Condensed Consolidated Balance Sheets
3
     
 
Unaudited Condensed Consolidated Statements of Comprehensive Income
4
     
 
Unaudited Condensed Consolidated Statements of Cash Flows
5
     
 
Notes to the Unaudited Condensed Consolidated Financial Statements
6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
16
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk
27
   
Item 4. Controls and Procedures
27
     
PART II. OTHER INFORMATION
 
     
Item 1. Legal Proceedings
28
     
Item 1A. Risk Factors
28
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
28
     
Item 3. Defaults Upon Senior Securities
28
   
Item 4. Other Information
28
     
Item 5. Exhibits
28
     
Signatures
29
 

 
2

 
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
September 30,
   
December 31,
 
   
2012
   
2011
 
   
US$
   
US$
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
   
51,029,961
     
135,482,386
 
Restricted cash
   
26,691,382
     
11,128,106
 
Time deposits
   
28,512,983
     
-
 
Accounts receivable, net of allowance for doubtful accounts
   
120,932,224
     
45,232,013
 
Amounts due from related parties
   
3,978
     
78,912
 
Inventories
   
67,478,022
     
44,953,958
 
Prepaid expenses and other current assets
   
11,101,365
     
12,857,223
 
Total current assets
   
305,749,915
     
249,732,598
 
Property, plant and equipment, net
   
131,475,063
     
100,933,429
 
Land use rights, net
   
4,013,356
     
4,055,363
 
Deposits for purchase of land use rights and plant
   
5,616,886
     
5,608,765
 
Deposits for purchase of equipment
   
34,547,013
     
-
 
Other non-current assets
   
239,202
     
264,662
 
Total assets
   
481,641,435
     
360,594,817
 
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCKS AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Short-term bank loans
   
65,276,540
     
31,459,032
 
Bills payable
   
37,869,145
     
22,243,760
 
Accounts payable
   
7,726
     
398,043
 
Amounts due to a related party
   
360,626
     
-
 
Income taxes payable
   
8,526,565
     
5,814,988
 
Accrued expenses and other current liabilities
   
5,731,414
     
3,213,181
 
Total current liabilities
   
117,772,016
     
63,129,004
 
Deferred income tax liabilities
   
20,994,428
     
22,102,431
 
Warrants liability
   
1,145,617
     
3,862,927
 
Embedded derivative liability
   
63
     
610
 
Total liabilities
   
139,912,124
     
89,094,972
 
Redeemable Series C convertible preferred stock
   
1,829
     
1,829
 
Redeemable Series D convertible preferred stock
   
97,576,465
     
97,576,465
 
Stockholders’ equity:
               
Series B preferred stock
   
100
     
100
 
Common stock, US$0.0001 par value, 500,000,000 shares authorized, 47,584,772 shares and 47,548,367 shares issued, 47,563,772 shares and 47,527,367 shares outstanding as of  September 30, 2012 and December 31, 2011, respectively
   
4,758
     
4,754
 
Treasury stock, at cost: 21,000 shares as of September 30, 2012 and December 31, 2011, respectively
   
(92,694
)
   
(92,694
)
Additional paid-in capital
   
71,998,076
     
71,190,659
 
Retained earnings
   
159,948,549
     
91,340,855
 
Accumulated other comprehensive income
   
12,292,228
     
11,477,877
 
Total stockholders’ equity
   
244,151,017
     
173,921,551
 
Commitments and contingencies
   
-
     
-
 
Total liabilities, redeemable convertible preferred stocks and stockholders’ equity
   
481,641,435
     
360,594,817
 

See accompanying notes to unaudited condensed consolidated financial statements. 
 

 
3

 
CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

   
Three-Month Period Ended
 September 30,
   
Nine-Month Period Ended 
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
US$
   
US$
   
US$
   
US$
 
                         
Revenues
   
163,368,820
     
103,820,442
     
431,208,409
     
267,694,860
 
Cost of revenues
   
(123,326,182
)
   
(77,289,477
)
   
(324,676,853
)
   
(201,133,363
)
    Gross profit
   
40,042,638
     
26,530,965
     
106,531,556
     
66,561,497
 
                                 
Selling expenses
   
(77,399
)
   
(40,311
)
   
(260,151
)
   
(217,571
)
General and administrative expenses
   
(2,235,107
)
   
(2,255,633
)
   
(7,588,166
)
   
(4,750,968
)
Research and development expenses
   
(5,471,242
)
   
(3,476,958
)
   
(12,536,739
)
   
(9,084,782
)
    Total operating expenses
   
(7,783,748
)
   
(5,772,902
)
   
(20,385,056
)
   
(14,053,321
)
                                 
    Operating income
   
32,258,890
     
20,758,063
     
86,146,500
     
52,508,176
 
                                 
Interest income
   
1,406,161
     
202,332
     
3,826,177
     
230,701
 
Interest expense
   
(1,156,056
)
   
(489,718
)
   
(2,555,099
)
   
(1,312,946
)
Change in fair value of embedded derivative liability
   
235
     
(72
 )
   
547
     
469
 
Change in fair value of warrants liability
   
854,991
     
(345,295
 )
   
2,717,310
     
2,353,777
 
    Total non-operating income (expenses), net
   
1,105,331
     
(632,753
 )
   
3,988,935
     
1,272,001
 
                                 
    Income before income taxes
   
33,364,221
     
20,125,310
     
90,135,435
     
53,780,177
 
                                 
Income tax expense
   
(8,091,572
)
   
(4,399,716
)
   
(21,527,651
)
   
(11,767,852
)
                                 
    Net income
   
25,272,649
     
15,725,594
     
68,607,784
     
42,012,325
 
                                 
Earnings per share of common stock:
                               
Basic
   
0.40
     
0.33
     
1.08
     
0.88
 
Diluted
   
0.40
     
0.33
     
1.08
     
0.86
 
                                 
Net Income
   
25,272,649
     
15,725,594
     
68,607,784
     
42,012,325
 
                                 
Other comprehensive income
                               
  Foreign currency translation adjustment, net of nil income taxes
   
2,840,914
     
1,827,861
     
814,351
     
4,517,857
 
                                 
Comprehensive income
   
28,113,563
     
17,553,455
     
69,422,135
     
46,530,182
 
                                 


See accompanying notes to unaudited condensed consolidated financial statements.
 
 
4

 
 

CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

   
Nine-Month Period Ended September 30,
 
   
2012
   
2011
 
   
US$
   
US$
 
Cash flows from operating activities:
           
Net cash provided by (used in) operating activities
   
(12,423,558
 )
   
54,506,421
 
                 
Cash flows from investing activities:
               
Purchases of and deposits for property, plant and equipment and land use rights
   
(72,155,807
)
   
(28,547,852
)
Purchase of time deposits
   
(28,308,042
)
   
-
 
Proceeds from sales of property, plant and equipment
   
-
     
107,748
 
Net cash used in investing activities
   
(100,463,849
)
   
(28,440,104
)
                 
Cash flows from financing activities:
               
Proceeds from bank borrowings
   
111,408,621
     
31,410,498
 
Repayments of bank borrowings
   
(77,879,405
)
   
(21,570,984
)
Placement of restricted cash as collateral for bank borrowings
   
(4,733,643
)
   
-
 
Payments for stock repurchase
   
-
     
(92,694
)
Proceeds from issuance of redeemable Series D convertible preferred stock
   
-
     
100,000,000
 
Payments of issuance cost of redeemable Series D convertible preferred stock
   
-
     
(564,163
)
Dividends paid to redeemable Series C convertible preferred stockholders
   
(60)
     
(210
)
Net cash provided by financing activities
   
28,795,513
     
109,182,447
 
                 
Effect of foreign currency exchange rate changes on cash and cash equivalents
   
(360,531
)
   
807,094
 
Net increase (decrease) in cash and cash equivalents
   
(84,452,425
 )
   
136,055,858
 
                 
Cash and cash equivalents at beginning of period
   
135,482,386
     
22,720,766
 
Cash and cash equivalents at end of period
   
51,029,961
     
158,776,624
 
                 
Supplemental disclosure of cash flow information:
               
Interest paid
   
2,084,010
     
1,312,946
 
Income taxes paid
   
19,978,772
     
7,850,831
 
                 
Non-cash investing and financing activities:
               
Accrual for purchase of equipment
   
-
     
2,050,665
 
Accrual of issuance cost of Series D convertible preferred stock
   
-
     
358,372
 
Inducement cost in connection with the issuance of Redeemable Series D convertible preferred stock
   
-
     
1,501,000
 

See accompanying notes to unaudited condensed consolidated financial statements.
 
 
 
5

 
CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Note 1 - Basis of presentation, significant concentrations and risks

(a) Basis of presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted as permitted by rules and regulations of the United States Securities and Exchange Commission. The condensed consolidated balance sheet as of December 31, 2011 was derived from the audited consolidated financial statements of China XD Plastics Company Limited (“China XD Plastics”) and subsidiaries (collectively, the ‘‘Company’’). The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated balance sheet of the Company as of December 31, 2011, and the related consolidated statements of comprehensive income, changes in equity and cash flows for the year then ended, included in the Company’s Annual Report on Form 10-K filed with the SEC.

In the opinion of the management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the financial position as of September 30, 2012, the results of operations for the three-month periods ended September 30, 2012 and 2011, and the results of operations and cash flows for the nine-month periods ended September 30, 2012 and 2011, have been made.

The preparation of consolidated financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the recoverability of the carrying amounts of property, plant and equipment, the realizability of inventories and deferred income tax assets, the useful lives of property, plant and equipment, the collectibility of accounts receivable, the fair values of financial instruments and stock-based compensation awards, and the accruals for tax uncertainties and other contingencies. The current economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.

(b) Significant concentrations and risks

Sales concentration

The Company sells its products, substantially through approved distributors in the PRC, to customers in the automotive industry. The Company’s sales are highly concentrated. Sales to five and four major distributors, which individually exceeded 10% of the Company’s revenues, accounted for approximately 88.4% and 72.4% of the Company’s total revenues for the three-month periods ended September 30, 2012 and 2011, respectively. Sales to five and four major distributors, which individually exceeded 10% of the Company’s revenues, accounted for approximately 84.9% and 73.5% of the Company's total revenues for the nine-month periods ended September 30, 2012 and 2011, respectively.

The Company expects revenues from these distributors to continue to represent a substantial portion of its revenues in the future. Any factors adversely affecting the automobile industry in the PRC or the business operations of these customers will have a material effect on the Company’s business, financial position and results of operations.

Purchase concentration

The principal raw materials used for the Company’s production of modified plastics products are plastic resins, such as polypropylene, ABS and polyamide. The Company purchases substantially all of its raw materials from three distributors.  Raw material purchases from these three suppliers, which individually exceeded 10% of the Company’s total raw material purchases, accounted for approximately 99.2% and 97.7% of the Company’s total raw material purchases for the three-month periods ended September 30, 2012 and 2011, respectively, and 99.6% and 99.9% of the Company's total raw material purchases for the nine-month periods ended September 30, 2012 and 2011, respectively. Management believes that other suppliers could provide similar raw materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would adversely affect the Company’s business, financial position and results of operations.
 
The majority owner of a major raw material distributor that supplied approximately 20.8% and 27.3% of the Company’s total raw material purchases for the three-month periods ended September 30, 2012 and 2011, respectively, and 23.9% and 25.9% of the Company's total raw material purchases for the nine-month periods ended September 30, 2012 and 2011, respectively, is also the majority owner of a sales distributor of the Company, as well as the major equipment distributor of the Company. Sales to this customer were approximately 14.8% and 13.7% of the Company’s total revenues for the three-month periods ended September 30, 2012 and 2011, respectively, and 14.7% and 13.3% of the Company's total revenues for the nine-month periods ended September 30, 2012 and 2011, respectively. Purchases from this major equipment distributor accounted for 99.8% and 97.9% of the Company's total equipment purchases for the nine-month ended September 30, 2012 and 2011, respectively.

 
6

 
Cash concentration

Cash, cash equivalents, restricted cash and time deposits maintained at banks consist of the following:

   
September 30,
2012
   
December 31,
2011
 
     
US$
     
US$
 
RMB denominated bank deposits with financial institutions in the PRC
   
98,318,498
     
137,503,064
 
US dollar denominated bank deposits with a financial institution in the U.S.
   
32,600
     
36,280
 
US dollar denominated bank deposits with financial institutions in the PRC
   
7,828,156
     
8,589,666
 
US dollar denominated bank deposits with a financial institution in Hong Kong Special Administrative Region
   
55,001
     
478,832
 
 
Time deposits, which all mature within one year as of the balance sheet date, represent certificates of deposit with an initial term of greater than three months when purchased. The effective interest rate per annum of time deposits as of September 30, 2012 was 3.1%.

Cash that is restricted as to withdrawal or usage is reported as restricted cash in the condensed consolidated balance sheets and is not included as cash and cash equivalents in the condensed consolidated statements of cash flows. Short-term bank deposits that are pledged as collateral for short-term bank borrowings are reported as restricted cash and amounted to US$4,733,643 and nil as of September 30, 2012 and December 31, 2011, respectively. The cash flows from such bank deposits are reported within cash flows from financing activities in the condensed consolidated statements of cash flows. Short-term bank deposits that are pledged as collateral for bills payable relating to purchase of raw materials are reported as restricted cash and amounted to US$21,957,739 and US$11,128,106 as of September 30, 2012 and December 31, 2011, respectively. Upon maturity and repayment of the bills payable, which is generally within 6 months, the cash becomes available for use by the Company. The cash flows from the pledged bank deposits relating to purchases of raw materials are reported within cash flows from operating activities in the condensed consolidated statements of cash flows.

The bank deposits with financial institutions in the PRC are uninsured by the government authority.  To limit exposure to credit risk relating to bank deposits, the Company primarily places bank deposits with large financial institutions in the PRC with acceptable credit rating.
 
Note 2 - Accounts receivable

Accounts receivable consist of the following:

   
September 30,
2012
 
December 31,
2011
   
US$
 
US$
         
Accounts receivable
   
121,079,626
 
45,345,837
Allowance for doubtful accounts
   
(147,402
)
(113,824)
Accounts receivable, net
   
120,932,224
 
45,232,013

The Company recorded provision for doubtful accounts of nil and US$33,578 during the three-month and nine-month periods ended September 30, 2012. There was no write-off of accounts receivables during the nine-month period ended September 30, 2012 and 2011.
 

 
 
7

 
Note 3 - Inventories

Inventories consist of the following:

 
September 30,
2012
 
December 31,
2011
 
 
US$
 
US$
 
         
Raw materials
   
56,716,845
     
37,645,204
 
Work in progress
   
120,736
     
164,144
 
Finished goods
   
10,640,441
     
7,144,610
 
Total inventories
   
67,478,022
     
44,953,958
 
 
There were no write down of inventories during the nine-month periods ended September 30, 2012 and 2011.

Note 4 – Prepaid expenses and other current assets

Prepaid expenses and other current assets consist of the following:

   
September 30,
2012
 
December 31,
2011
   
US$
 
US$
         
Advances to suppliers
   
            9,715,513
 
12,522,985
Others
   
            1,385,852
 
334,238
Total prepaid expenses and other current assets
   
11,101,365
 
12,857,223

Consistent with the common industry practice in the PRC, the Company is required to pay deposits to the suppliers for the 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 advances to suppliers as of September 30, 2012 are related to the purchase of raw materials, which were subsequently received by the Company in October 2012.

Others mainly include interest receivable, other prepaid expenses and staff advances.

Note 5 – Property, plant and equipment, net

Property, plant and equipment consist of the following:
 
   
September 30,
2012
   
December 31,
2011
 
   
US$
   
US$
 
                 
Machinery, equipment and furniture
   
119,849,841
     
92,363,611
 
Motor vehicles
   
1,058,977
     
961,130
 
Plant and buildings
   
17,865,789
     
17,762,660
 
Construction in progress
   
11,946,184
     
1,468,408
 
Total property, plant and equipment
   
150,720,791
     
112,555,809
 
Less accumulated depreciation
   
(19,245,728
)
   
(11,622,380
)
    Property, plant and equipment, net
   
131,475,063
     
100,933,429
 
 
Depreciation expense was US$7,558,655 and US$3,857,591 for the nine-month periods ended September 30, 2012 and 2011, respectively, and US$2,616,698 and US$1,303,559 for the three-month periods ended September 30, 2012 and 2011, respectively. For the three-month and nine-month periods ended September 30, 2012 and 2011, interest expense capitalized as a component of the cost of construction-in-progress was inconsequential.
 
 
8

 
Note 6 – Deposits for purchase of equipment
 
In April 2012, the Company’s subsidiaries, Harbin Xinda Plastics Material Research Center Co., Ltd (“Xinda Material Research Center”) and Heilongjiang Xinda Enterprise Group Company Limited (“Xinda Group”), entered into equipment purchase agreements with Harbin Jiamu Import and Export Trading Co., Ltd. (“Harbin Jiamu”), pursuant to which Xinda Material Research Center and Xinda Group will purchase equipment from Harbin Jiamu for a consideration of RMB511,455,000 (approximately US$81,379,678) and RMB90,063,536 (approximately US$14,330,374) in cash, respectively.  

In July 2012, Xinda Material Research Center entered into an equipment purchase agreement with Harbin Jiamu to purchase equipments for a consideration of RMB85,190,000 (approximately US$13,554,926).
 
As of September 30, 2012, the Company made payments in the amount of RMB448,593,321 (equivalent to US$71,377,502) to Harbin Jiamu and the Company received equipment in the amount of RMB231,472,255  (equivalent to US$36,830,489) from Harbin Jiamu under the purchase agreements.  The rest of equipment in the amount of RMB455,236,311 (equivalent to US$72,434,494) is expected to be installed in the three workshops and put into use by December 2012.
 
Note 7 – Short-term bank loans

   
September 30,
2012
   
December 31,
2011
 
   
US$
   
US$
 
             
Unsecured loans under the line of credit
   
41,608,325
     
-
 
Loans secured by cash
   
23,668,215
     
-
 
Loans secured by property, plant and equipment and land use rights
           
15,570,632
 
Loans secured by equipment of Harbin Xinda High-Tech Co., Ltd. (“Xinda High-Tech”) and guaranteed by Mr. Han Jie (“Mr. Han”), the chief executive officer and controlling stockholder of the Company and his wife
   
-
     
15,888,400
 
Total short-term bank loans
   
65,276,540
     
31,459,032
 

As of September 30, 2012 and December 31, 2011, the Company’s short-term bank loans bear a weighted average interest rate of 6.4% and 6.1% per annum, respectively. All short-term bank loans mature and expire at various times within one year and contain no renewal terms.

On January 17, 2012, the Company obtained a revolving one-year line of credit in the amount of RMB100 million (approximately US$15.7 million) from a PRC bank in Harbin, Heilongjiang province. As of September 30, 2012, the line of credit was fully utilized.
 
On April 1, 2012, the Company borrowed a one-year line of credit loan of RMB50 million (approximately US$8.0 million) from a PRC bank in Harbin, Heilongjiang province. As of September 30, 2012, the line of credit was fully utilized.
 
On June 20, 2012, the Company obtained a revolving one-year line of credit in the amount of RMB120 million (approximately US$19.1 million) from a PRC bank in Harbin, Heilongjiang province.  Pursuant to the line of credit agreement, the bank will directly pay to one of the Company’s raw material vendors for the purchases of raw materials, upon the request of drawdown by the Company.  The Company is required to maintain a deposit equal to 20% of the outstanding loan balance as a guarantee.  Cash of RMB29.8 (approximately US$4.8 million) was deposited in the bank as of September 30, 2012.  Total bank loan from this line of credit was RMB148.8 million (approximately US$23.7 million) as of September 30, 2012.

 
9

 
On June 28, 2012, the Company obtained a revolving one-year line of credit in the amount of RMB94.3 million (approximately US$15.0 million) from Hong Kong and Shanghai Banking Corp (“HSBC”). Pursuant to the line of credit agreement, the bank will directly pay to one of the Company’s raw material vendors for the purchases of raw materials, upon the request of drawdown by the Company.  As of September 30, 2012, the Company borrowed RMB81.5 million (approximately US$13.1 million) from HSBC under this line of credit, and RMB12.8 million (approximately US$1.9 million) is available to be utilized.  The bank credit facility contains certain financial covenants.  One of the covenants requires the Company’s total stockholders’ equity (exclusive of redeemable Series C convertible preferred stock, and redeemable Series D convertible preferred stock) to be no lower than US$250 million at any time. As of September 30, 2012, the Company did not to meet this financial covenant.  On November 5 2012, HSBC and the Company signed a supplemental agreement to amend this financial covenant. The amendment stipulates that the Company’s total stockholders’ equity (inclusive of redeemable Series C convertible preferred stock, and redeemable Series D convertible preferred stock) to be no lower than US$250 million at any time.

On August 28, 2012, the Company obtained a revolving one-year line of credit in the amount of RMB30 million (approximately US$4.8 million) from a PRC bank in Harbin, Heilongjiang province. As of September 30, 2012, the line of credit was fully utilized.
 
Note 8 - Accrued expenses and other current liabilities

Accrued expenses and other current liabilities consist of the following:
 
   
September 30,
2012
   
December 31,
2011
 
   
US$
   
US$
 
             
Payables for purchase of property, plant and equipment
   
2,071,800
     
2,199,951
 
Accrued payroll
   
1,315,255
     
25,352
 
Tax payables
   
  827,442
     
560,723
 
Others
   
1,516,917
     
427,155
 
Total accrued expenses and other current liabilities
   
5,731,414
     
3,213,181
 

Others mainly represent accrued professional service expenses, employee benefits, utility charges, interest expense and other accrued miscellaneous operating expenses.
 
Note 9 - Related party transactions

During the periods presented, the Company entered into related party transactions with Xinda High-Tech, an entity controlled by the wife of Mr. Han, the chief executive officer and controlling stockholder of the Company, and Mr. Han’s son.  The significant related party transactions are summarized as follows:

   
Three-Month Period Ended September 30,
   
Nine-Month Period Ended September 30,
 
   
2012
 
2011
   
2012
   
2011
 
   
US$
 
US$
   
US$
   
US$
 
Costs and expenses resulting from transactions with  related parties:
                           
Rental expenses for plant and office spaces
(a)
192,270
   
84,660
     
448,359
     
253,979
 

 
10

 
The balances due from and to the related parties are summarized as follows:
 
     
September 30,
2012
 
December 31,
2011
     
US$
 
US$
Amounts due from related parties:
         
Prepaid rental expenses to Xinda High-Tech
(a)
   
-
 
78,912
Prepaid rental expenses to Mr. Han’s son
(a)
   
3,978
 
-
Total
     
3,978
 
78,912
             
Amounts due to a related party:
           
Rental payable to Xinda High-Tech
(a)
   
360,626
 
-

(a)
The Company rents or rented the following plant and office buildings in Harbin, Heilongjiang province from Xinda High-Tech.  The Company renewed the lease agreements with Xinda High-Tech which expired on April 30, 2012 for another three years starting from May 1, 2012.
 
Premise Leased
 
Area (M2)
   
Annual Rental Fee (US$)
 
Period of Lease
Plant and office building
   
23,894
     
318,228
 
Between May 1, 2009 and April 30, 2012
Office building
   
2,800
     
31,823
 
Between June 1, 2010 and April 30, 2012
Office building
   
500
     
9,547
 
Between January 1, 2011 and April 30, 2012
Office building
   
213
     
8,910
 
Between January 1, 2012 and April 30, 2012
Plant and office building
   
20,500
     
652,353
 
Between May 1, 2012 and April 30, 2015
Office building
   
3,394
     
108,007
 
Between May 1, 2012 and April 30, 2015

The Company also rents a facility of approximately 3,134 square meters in Harbin, Heilongjiang province from Mr. Han’s son for an annual rental fee of RMB100,000 (approximately US$15,911).  The period of the lease is from January 1, 2012 to December 31, 2012.

Total rental expenses paid or payable to Xinda High-Tech and Mr. Han’s son amounted to US$192,270 and US$84,660 during the three-month periods, and US$448,359 and US$253,979 during the nine-month periods ended September 30, 2012 and 2011, respectively.
 
Note 10 - Income tax

In 2008, Harbin Xinda Macromolecule Material Co., Ltd. (“Harbin Xinda”) qualified as an Advanced and New Technology Enterprise (“ANTE”).  In 2011, Harbin Xinda renewed its ANTE qualification, which entitled it to the preferential income tax rate of 15% from January 1, 2011 to December 31, 2013.  In December 2011, Heilongjiang Xinda Enterprise Group Co., Ltd. (“Xinda Group”) was established and is subject to income tax at 25%.  In January 2012, as a result of an internal reorganization, Harbin Xinda merged into Xinda Group. Xinda Group remains subject to income tax at 25% after the merger.

The effective income tax rates for the nine-month periods ended September 30, 2012 and 2011 were 23.9% and 21.9%, respectively. The effective income tax rate for the nine-month period ended September 30, 2012 differs from the PRC statutory income tax rate of 25% primarily due to the additional 50% deduction against taxable income for certain research and development expenses incurred by two research centers of the Company. 

As of September 30, 2012 and December 31, 2011, full valuation allowances of US$1,384,555 and US$1,005,361 were provided against the deferred income tax assets of entities which were in cumulative loss positions.

As of and for the nine-month period ended September 30, 2012, the Company did not have any unrecognized tax benefits, and thus no interest and penalties related to unrecognized tax benefits were recorded. In addition, the Company does not expect that the amount of unrecognized tax benefits will change significantly within the next 12 months.
 
 
11

 
Note 11 - Warrants

The following is a summary of outstanding warrants as of September 30, 2012:

Warrants
 
Exercise Price
   
Number of Warrants
Outstanding
   
Remaining
Contractual Life
 
   
US$
         
Years
 
Series A investor warrants
   
4.9
     
1,320,696
     
2.17
 
Series A placement agent warrants
   
5.5
     
117,261
     
2.17
 
Series C placement agent warrants
   
7.5
     
166,667
     
0.76
 
             
1,604,624
         

The fair values of the warrants as of September 30, 2012 were calculated using Black-Scholes option pricing model with the following assumptions:

   
Series A Investor
Warrants
 
Series A Placement
Agent Warrants
 
Series C Placement
Agent Warrants
Volatility
 
50.7%
 
50.7%
 
38.9%
Expected dividends yield
   
0%
 
0%
 
0%
Fair value of underlying common stock (per share)
   
3.82
 
3.82
 
3.82
Risk-free interest rate (per annum)
   
0.26%
 
0.26%
 
0.18%

During the three-month periods and nine-month periods ended September 30, 2012 and 2011, no warrants were exercised.  
 
Note 12 - Stockholders’ equity

The changes of each caption of stockholders’ equity for the nine-month period ended September 30, 2012 are as follows:
 
   
Series B Preferred Stock
 
Common Stock
                     
   
Number
of Shares
 
Amount
 
Number
of Shares
   
Amount
 
Treasury Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other
Comprehensive
Income
 
Total
Stockholders’ Equity
 
       
US$
       
US$
                     
Balance as of January 1, 2012
    1,000,000     100     47,527,367       4,754     (92,694 )   71,190,659     91,340,855     11,477,877     173,921,551  
Net income
    -     -     -       -     -     -     68,607,784     -     68,607,784  
Other comprehensive loss
    -     -     -       -     -     -     -     814,351     814,351  
Dividends to redeemable Series C convertible preferred stockholders
    -     -     -       -     -     -     (90 )   -     (90 )
Vesting of nonvested shares
    -     -     36,405       4     -     (4 )   -     -     -  
Stock based compensation
    -     -     -       -     -     807,421     -     -     807,421  
Balance as of September 30, 2012
    1,000,000     100     47,563,772       4,758     (92,694 )   71,998,076     159,948,549     12,292,228     244,151,017  
                                                           
 
 
12

 
Note 13 - Stock based compensation

A summary of stock option activities is as follows: 
   
Number of
Options
Outstanding
   
Weighted Average
Exercise Price
US$
 
Weighted Average
Remaining
Contractual Life
Years
 
Aggregate Intrinsic Value
US$
Outstanding as of December 31, 2011
   
297,000
     
8.01
       
Grant
   
-
     
-
       
Forfeited
   
-
     
-
       
Exercised
   
-
     
-
       
Expired
   
(148,500)
     
8.01
       
Outstanding as of September 30, 2012
   
148,500
     
8.01
 
7.86
 
-
Vested and expected to vest as of September 30, 2012
   
148,500
     
8.01
 
7.86
 
-
Exercisable as of September 30, 2012
   
-
     
-
       
 
The Company recognized US$83,744 and US$83,744 of share-based compensation expense in general and administration expenses relating to stock options for the three-month periods ended September 30, 2012 and 2011, respectively, and US$248,500 and US$248,500 of share-based compensation expense in general and administration expenses relating to stock options for the nine-month periods ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there was US$283,257 of total unrecognized compensation cost relating to stock options, which is to be recognized over a period of 0.85 years.

A summary of the nonvested shares activity is as follows:
 
   
Number of
Nonvested Shares
   
Weighted Average
Grant Date Fair Value
Per share
 
         
US$
 
Balance as of December 31, 2011
    106,405       6.03  
Grant
    465,000       4.41  
Vested
    (36,405 )     4.39  
Outstanding as of September 30, 2012
    535,000       4.73  
 
On August 7, 2012, the Company’s Board of Directors approved the grant of (i) 230,000 nonvested shares to certain executive officers and employees which vest on the third anniversary of the date of grant, (ii) 225,000 nonvested shares to 15 consultants which vest on February 7, 2013, and (iii) 10,000 nonvested shares to a former employee which vest on the date of grant.

The Company recognized US$417,364 and US$43,800, and US$558,921 and US$157,491 of compensation expense in general and administration expenses relating to nonvested shares for the three-month periods and nine-month periods ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there was US$1,721,011 of total unrecognized compensation cost relating to nonvested shares, which is to be recognized over a weighted average period of 1.80 years.
 

 
 
13

 
Note 14 - Earnings per share

Basic and diluted earnings per share are calculated as follows:


   
Three-Month Period Ended September 30,
   
Nine-Month Period Ended September 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
US$
   
US$
   
US$
   
US$
 
Numerator:
                               
Net income
   
25,272,649
     
15,725,594
     
68,607,784
     
42,012,325
 
Less: Dividends to Series C convertible preferred stockholders
   
(30)
     
(30)
     
(90)
     
(90)
 
Net income available to common stockholders
   
25,272,619
     
15,725,564
     
68,607,694
     
42,012,235
 
Less:
                               
Earnings allocated to participating Series C convertible preferred stock
   
(172)
     
(144)
     
(468)
     
(382)
 
Earnings allocated to participating Series D convertible preferred stock
   
(6,326,835)
     
(170,399)
     
(17,225,253)
     
(154,522)
 
Earnings allocated to participating nonvested shares
   
(139,195)
     
(26,128)
     
(196,695)
     
(72,736)
 
Net income for basic earnings per share
   
18,806,417
     
15,528,893
     
51,185,278
     
41,784,595
 
                                 
Changes in fair value of derivative liabilities - Series A investor warrants
   
-
     
-
     
-
     
(937,739)
 
Net income for diluted earnings per share
   
18,806,417
     
15,528,893
     
51,185,278
     
40,846,856
 
                                 
Denominator:
                               
Denominator for basic earnings per share:
                               
Weighted average number of common stock outstanding
   
47,559,750
     
47,547,910
     
47,544,408
     
47,545,449
 
Contract to be settled in common stock
   
-
     
144,022
     
-
     
144,022
 
Series A investor warrants
   
                -
     
-
     
-
     
36,943
 
Denominator for diluted earnings per share
   
    47,559,750
     
47,691,932
     
47,544,408
     
47,726,414
 
Earnings per share:
                               
Basic
   
0.40
     
0.33
     
1.08
     
0.88
 
Diluted
   
0.40
     
0.33
     
1.08
     
0.86
 

The following table summarizes potentially dilutive securities excluded from the calculation of diluted earnings per share for the three-month periods and nine-month periods ended September 30, 2012 and 2011 because their effects are anti-dilutive:

   
Three-Month Period Ended September 30,
   
Nine-Month Period Ended September 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Shares issuable upon exercise of Series A investor warrant
   
1,320,696
     
1,320,696
     
1,320,696
     
-
 
Shares issuable upon exercise of Series A placement agent warrant
   
117,261
     
117,261
     
117,261
     
117,261
 
Shares issuable upon exercise of Series C investor warrants
   
-
     
1,666,667
     
-
     
1,666,667
 
Shares issuable upon exercise of Series C placement agent warrant
   
166,667
     
166,667
     
166,667
     
166,667
 
Shares issuable upon exercise of stock options
   
148,500
     
297,000
     
148,500
     
297,000
 
 
 
 
 
14

 
 
Note 15 - Commitments and contingencies

(1)  
Lease commitments
 
Future minimum lease payments under non-cancellable operating leases agreements as of September 30, 2012 were as follows. The Company’s leases do not contain any contingent rent payments terms.

   
US$
 
Period from October 1, 2012 to December 31, 2012
   
207,746
 
Years ending December 31,
       
2013
   
773,917
 
2014
   
754,894
 
2015
   
251,631
 
2016
   
-
 
2017 and thereafter
   
-
 
 

Rental expenses incurred for operating leases of plant and equipment and office spaces were US$214,243 and US$98,285 for the three-month periods, and US$511,738 and US$298,064 for the nine-month periods ended September 30, 2012 and 2011, respectively. There are no step rent provisions, escalation clauses, capital improvement funding requirements, other lease concessions or contingent rent in the lease agreements. The Company has no legal or contractual asset retirement obligations at the end of the leases.

(2)             Plant construction

Pursuant to the agreement with Harbin Shengtong Engineering Plastics Co. Ltd., the Company has a commitment of RMB316,937,900 (equivalent to US$50,429,274) as of September 30, 2012, for the acquisition of land use rights and a production plant consisting of five workshops and a building upon completion of the project.

(3)             Warehouse construction

Pursuant to the agreement with Oriental International Construction Engineering Company Limited, the Company has a commitment of RMB4,932,698 (equivalent to US$784,862) as of September 30, 2012, for the construction of a warehouse.
 
(4)             Equipment acquisition

As of September 30, 2012, the Company has a commitment of RMB251,967,042 (equivalent to US$40,091,497) for the acquisition of equipment.
 
 
 
 
15

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

Overview

China XD Plastics Company Limited (“China XD”, “we”, and the “Company”, and “us” or “our” shall be interpreted accordingly) is one of the 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 operating subsidiaries in China, we develop modified plastics using our proprietary technology, manufacture and sell our products primarily for use in the fabrication of automobile parts and components. We have received 236 certifications from manufacturers in the automobile industry as of September 30, 2012. 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 103 professionals and  16 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 integration of our academic and technological expertise, we have a portfolio of 53 patents, one of which we have obtained the patent rights and the remaining 52 of which we have applications pending in China as of September 30, 2012.
 
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 polyether ether ketone (PEEK). The Company's products are primarily used in the production of exterior and interior trim and functional components of more than 23 automobile brands and 70 automobile models manufactured in China, including Audi, Volkswagen, BMW, GM, Mazda, Toyota, Cherry, Geely and Hafei new energy vehicles. Our 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 production bases in Harbin, Heilongjiang in the PRC. As of September 30, 2012, we had approximately 255,000 metric tons of production capacity across 58 automatic production lines utilizing German twin-screw extruding systems, automatic weighing systems and Taiwan conveyer systems. The construction of three additional workshops were recently completed and we are in the process of installing new production lines in these workshops, which would support our production capacity expansion beyond 2012. A launch of a trial run for these new production lines is expected in December 2012.
 
 
16

 
 
Highlights for the three months ended September 30, 2012 include:
 
 Revenue was US$163.3 million, an increase of 57.4% from US$103.8 million in the third quarter of 2011
 Gross profit was US$40.0 million, an increase of 50.9% from US$26.5 million in the third quarter of 2011
 Gross profit margin was 24.5%, compared to 25.6% in the third quarter of 2011
 Net income was US$25.3 million, compared to US$15.7 million in the third quarter of 2011
 Total volume shipped was 61,589 metric tons, up 57.7% from 39,057 metric tons in the third quarter of 2011
 
Results of Operations

The following table sets forth, for the periods indicated, statements of income data in millions of US$:
 
(in millions, except  percentage)
Three Months Ended
         
Nine Months Ended
     
 
September 30,
     
Change
   
September 30,
   
Change
 
2012 
   
2011
   
%
   
2012
   
2011
   
%
Revenues
  163.3
   
103.8
     
57.4
%
   
431.2
     
267.7
     
61.1
 %
Cost of revenues
  (123.3)
   
(77.3)
     
59.6
%
   
(324.7)
     
(201.1)
     
61.4
Gross profit
40.0
   
26.5
     
50.9
%
   
106.5
     
66.6
     
60.0
 %
Total operating expenses
  (7.7)
   
(5.8)
     
34.8
%
   
(20.4)
     
(14.1)
     
45.1
 %
Operating income
32.3
   
20.7
     
55.4
%
   
86.1
     
52.5
     
64.1
 %
Income before income taxes
  33.4
   
20.1
     
65.8
%
   
90.1
     
53.8
     
67.6
 %
Income tax expense
  (8.1)
   
(4.4)
     
83.9
%
   
(21.5)
     
(11.8)
     
82.9
 %
Net income
  25.3
   
15.7
     
60.7
%
   
68.6
     
42.0
     
63.3
 %

Three Months Ended September 30, 2012 compared to three months ended September 30, 2011

Revenues

Revenues were US$163.3 million in the third quarter ended September 30, 2012, an increase of US$59.5 million, or 57.4%, compared to US$103.8 million in the same period of last year, due to approximately 57.7% increase in sales volume and 3.6% 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 installed twenty production lines in December 2011, as well as the marketing efforts to develop new customers. Such increase in demand was driven by increasing demand for middle and high-end automobiles by Chinese consumers, continuing substitution of imported modified plastics by domestic suppliers, as well as the increase of plastic content on the per-vehicle-basis in China. 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 that we have been able to effectively pass through to our customers. 
 
 
17

 
The following table summarizes the breakdown of revenues by product mix in millions of US$:
 
(in millions, except percentage)
Revenues
For the Three Months Ended September 30,
         
 
2012
 
2011
         
 
Amount
   
%
 
Amount
   
%
 
Change in Amount
 
Change in
%
Modified Polypropylene (PP)
80.1
   
49.0
%
 
42.5
   
41.1
%
 
37.6
 
87.9
%
                                 
Engineering Plastics
32.9
   
20.1
%
 
20.8
   
20.1
%
 
12.1
 
57.9
%
                                 
Modified Polyamide (PA)
12.9
   
7.9
%
 
6.8
   
6.5
%
 
6.1
 
90.6
%
                                 
Alloy Plastics
10.5
   
6.5
%
 
9.9
   
9.5
%
 
0.6
 
6.7
%
                                 
Environment Friendly Plastics
18.4
   
11.3
%
 
9.9
   
9.5
%
 
8.5
 
86.2
 %
                                 
Modified Acrylonitrile Butadiene Styrene (ABS)
6.9
   
4.2
%
 
7.8
   
7.5
%
 
(0.9
)
(10.8
)%
                                 
     Sub-total
161.7
   
99.0
%
 
97.7
   
94.2
%
 
64.0
 
65.5
%
                                 
After-sales Service
1.6
   
1.0
%
 
6.1
   
5.8
%
 
(4.5
)
(73.1
)%
Total Revenues
163.3
   
100
%
 
103.8
   
100
%
 
59.5
 
57.4
%


The following table summarizes the breakdown of metric tons (MT) by product mix:
 
(in MTs, except percentage)
   
Sales Volume
 For the Three Months Ended September 30,
           
     
2012
   
2011
           
     
MT
     
%
   
MT
     
%
 
Change in 
MT
   
Change in 
%
Modified Polypropylene (PP)
   
38,469
     
62.6
%
   
22,763
     
58.3
%
 
15,706
   
69.0
%
                                             
Engineering Plastics
   
6,661
     
10.8
%
   
4,385
     
11.2
%
 
2,276
   
51.9
                                             
Polyamide (PA)
   
2,737
     
4.4
%
   
1,580
     
4.0
%
 
1,157
   
73.3
%
                                             
Alloy Plastics
   
2,972
     
4.8
%
   
3,232
     
8.3
%
 
(260)
   
(8.0)
%
                                             
Environment Friendly Plastics
   
8,140
     
13.2
%
   
4,365
     
11.2
%
 
3,775
   
86.5
%
                                             
Modified Acrylonitrile Butadiene Styrene (ABS)
   
2,610
     
4.2
%
   
2,732
     
7.0
%
 
(122)
   
(4.5)
%
                                             
Total sales volume
   
61,589
     
100
%
   
39,057
     
100
%
 
22,532
   
57.7
%

The Company has continued its shift of product mix to higher-end product categories such as Environmental Friendly Plastics and Polyamide (PA) as well as enhance gross margin of other product categories, including Modified Polypropylene (PP), Engineering Plastics, Alloy Plastics, and Modified Acrylonitrile Butadiene Styrene (ABS) by focusing on applications used in higher-end car models, 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 Japan joint ventures, which tend to use more and higher-end modified plastics in quantity per vehicle in China.

 
18

 
Gross Profit and Gross Margin

   
Three Months Ended September 30,
   
Change
 
(in millions, except percentage)
 
2012
   
2011
   
Amount
   
%
 
Gross Profit
 
$
40.0
   
$
26.5
   
$
13.5
     
50.9
%
Gross Margin
   
24.5
%
   
25.6
           
(1.1)
%

Gross profit was US$40.0 million in the third quarter ended September 30, 2012 compared to US$26.5 million in the same period of 2011, representing an increase of 50.9%. Our gross margin decreased to 24.5% in the third quarter ended September 30, 2012 from 25.6% during the same quarter of 2011. The decrease was mainly attributed to increase of the price of raw materials, increase of depreciation, and increase of production related payroll expenses this year, partially offset by our efforts in developing and selling more higher value-added automotive modified plastics towards high-end products as a percentage of total sales in the third quarter ended September 30, 2012.
 
General and Administrative Expenses

   
Three Months Ended September 30,
   
Change
 
(in millions, except percentage)
 
2012
   
2011
   
Amount
   
%
 
General and Administrative Expenses
 
$
2.2
   
$
2.3
   
$
(0.1)
     
(0.9)
%
as a percentage of revenues
   
1.4
%
   
2.2
%
           
(0.8)
%

General and administrative (G&A) expenses were US$2.2 million in the third quarter ended September 30, 2012 which is consistent with the US$2.3 million in the same period in 2011.

Research and Development Expenses

   
Three Months Ended September 30,
   
Change
 
(in millions, except percentage)
 
2012
   
2011
   
Amount
   
%
 
Research and Development Expenses
 
$
5.5
   
$
3.5
   
$
2.0
     
57.4
%
as a percentage of revenues
   
3.4
%
   
3.4
%
           
(0.0)
%

Research and development (“R&D”) expenses were US$5.5 million during the quarter ended September 30, 2012 compared with US$3.5 million during the same period in 2011, an increase of US$2.0 million, or 57.4%, reflecting increased research and development activities on new products primarily in consumption of raw materials for various experiments for automotive applications from automobile manufacturers as well as other non-automotive applications.

As of September 30, 2012, the number of ongoing research and development projects is 147. We expect to complete and realize economic benefits on approximately 30% of the projects in the near term. The remaining projects are expected to be carried out for a longer period. The 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, high-speed rail, medical devices, etc.

Operating Income

Total operating income was US$32.3 million in the quarter ended September 30, 2012, compared to US$20.7 million in the same period of 2011, representing an increase of 55.4% or US$11.6 million. This increase is primarily due to higher gross profit, partially offset by higher R&D expenses. 
 
 
19

 
Other Income (Expense)

Interest Income (Expenses)
   
Three Months Ended September 30,
   
Change
 
(in millions, except percentage)
 
2012
   
2011
   
Amount
   
%
 
Interest Income
 
$
1.4
   
$
0.2
   
$
1.2
     
595.0%
 
Interest Expenses
   
(1.2)
     
(0.5)
     
(0.7)
     
136.1
%
Net Interest Income (Expenses)
 
$
0.2
   
$
(0.3)
   
$
0.5
     
(187.0)
%
as a percentage of revenues
   
0.2
%
   
(0.3)
%
           
0.5
%

Net interest income was US$0.2 million in the quarter ended September 30, 2012, compared to net interest expenses of US$0.3 million in the same period of 2011, primarily due to US$1.4 million interest income generated from time deposits in the third quarter of 2012.

Change in Fair Value of Warrants Liabilities

   
Three Months Ended September 30,
   
Change
 
(in millions, except percentage)
 
2012
   
2011
   
Amount
   
%
 
Change in Fair Value of Warrants Liabilities
 
$
0.9
   
$
(0.3)
   
$
1.2
     
347.6
%
as a percentage of revenues
   
0.5
%
   
(0.3)
%
           
0.8
%

Change in fair value of warrants liabilities was a gain of US$0.9 million in the quarter ended September 30, 2012, compared to a loss of US$0.3 million in the same period of 2011, primarily due to the change of fair value of warrants driven by the fluctuation of our stock price in respective periods. On a percentage basis, change in fair value of warrants liabilities in the third quarter of 2012 increased to 0.5% of revenues from 0.3% in the third quarter of 2011.

Income Taxes

   
Three Months Ended September 30,
   
Change
 
(in millions, except percentage)
 
2012
   
2011
   
Amount
   
%
 
Income before Income Taxes
 
$
33.4
   
$
20.1
   
$
13.3
     
65.8
%
Income Tax Expense
   
(8.1)
     
(4.4)
     
(3.7)
     
83.9
%
Effective income tax rate
   
24.3
%
   
21.9
%
           
2.4
%

The effective income tax rates for the three-month periods ended September 30, 2012 and 2011 were 24.3% and 21.9%, respectively. The effective income tax rate for the three-month period ended September 30, 2012 differs from the PRC statutory income tax rate of 25% primarily due to the additional 50% deduction against taxable income for certain eligible research and development expenses incurred by our research centers. 

Our PRC subsidiaries have US$106.2 million of cash and cash equivalents, restricted cash and time deposits as of September 30, 2012, which is planned to be permanently reinvested in the PRC. The distributions from our PRC subsidiaries are subject to the U.S. federal income tax at 34%, less any applicable foreign tax credits. Due to our policy of indefinitely reinvesting our earnings in our PRC business, we have not provided for deferred income tax liabilities on undistributed earnings of our PRC subsidiaries.
 
Net Income

As a result of the above factors, we had a net income of US$25.3 million in the third quarter of 2012, compared to net income of US$15.7 million in the same quarter of 2011.
 
 
20

 
 
 
Nine Months Ended September 30, 2012 compared to nine months ended September 30, 2011

Revenues

Revenues were US$431.2 million for the nine months ended September 30, 2012, an increase of US$163.5 million, or 61.1%, compared to US$267.7 million in the same period of last year, due to approximately 46.7% increase in sales volume and 10.9% 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 installed twenty production lines in December 2011, as well as the marketing efforts to develop new customers. Such increase in demand was driven by increasing demand for middle and high-end automobiles by Chinese consumers, continuing substitution of imported modified plastics by domestic suppliers, as well as the increase of plastic content on the per-vehicle-basis in China. 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 that we have been able to effectively pass through to our customers. 

Product Mix
 
The following table summarizes the breakdown of revenues by product mix in millions of US$:
 
(in millions, except percentage)
 
Revenues
 For the Nine months Ended September 30,
             
   
 2012
   
 2011
             
   
Amount
   
%
   
Amount
   
%
   
Change in Amount
   
Change in
%
 
Modified Polypropylene (PP)
   
216.1
     
50.2
%
   
138.1
     
51.6
%
   
78.0
     
56.5
%
                                                 
Engineering Plastics
   
83.5
     
19.4
%
   
44.6
     
16.7
%
   
38.9
     
87.2
%
                                                 
Polyamide (PA)
   
36.1
     
8.4
%
   
17.1
     
6.4
%
   
19.0
     
111.0
%
                                                 
Alloy Plastics
   
29.9
     
6.9
%
   
19.0
     
7.1
%
   
10.9
     
57.4
%
                                                 
Environment Friendly Plastics
   
43.2
     
10.0
%
   
20.4
     
7.6
%
   
22.8
     
111.7
%
                                                 
Modified Acrylonitrile Butadiene Styrene (ABS)
   
16.6
     
3.8
%
   
15.7
     
5.8
%
   
0.9
     
5.8
%