China XD Plastics Co Ltd - FORM 10-Q

Attached files

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EX-32.2 - EXHIBIT 32.2 - China XD Plastics Co Ltd	ex32x2.htm
EX-32.1 - EXHIBIT 32.1 - China XD Plastics Co Ltd	ex32x1.htm
EX-31.1 - EXHIBIT 31.1 - China XD Plastics Co Ltd	ex31x1.htm
EX-31.2 - EXHIBIT 31.2 - China XD Plastics Co Ltd	ex31x2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

o	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _________to ___________

000-53131

(Commission file number)

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 Number)

No. 9 Dalian North Road, Haping Road Centralized Industrial Park,

Harbin Development Zone, Heilongjiang Province, PRC 150060

(Address of principal executive offices)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer o

Non-accelerated filer o Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of August 10, 2011, there were 47,628,367 issued and outstanding shares of the issuer’s common stock.

CHINA XD PLASTICS COMPANY LIMITED

Index

PART I— FINANCIAL INFORMATION		Page

Item 1.	Condensed Consolidated Financial Statements (Unaudited)	2
	Notes to the Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	45
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	59
Item 4.	Controls and Procedures	60

PART II— OTHER INFORMATION

Item 1.	Legal Proceedings	61
Item 1A.	Risk Factors	61
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63
Item 3.	Defaults Upon Senior Securities	63
Item 4.	(Removed and Reserved)	63
Item 5.	Other Information	63
Item 6.	Exhibits	63

SIGNATURES		64

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

CHINA XD PLASTICS COMPANY LIMITED

CONDENSED CONSOLIDATED BALANCE SHEETS


	Note	June 30, 2011		December 31, 2010

ASSETS

Current assets:
Cash and cash equivalents		$	46,860,085	$	22,720,766
Notes receivable			563,710		402,405
Accounts receivable - net of allowance for doubtful receivables of
$47,052 and $33,136, respectively	3		30,723,563		28,615,995
Prepaid expenses and other receivables			72,038		431,074
Inventories	4		19,133,623		25,257,083
Due from related parties	10		-		75,732
Advances to employees	5		444,740		559,546
Advances to suppliers	2		35,735,868		31,937,098
Taxes receivable			339,893		116,882

Total current assets			133,873,520		110,116,581

Property, plant and equipment, net	6		48,172,412		49,038,103

Deposit to acquire land use rights and construction in progress	7		12,827,230		-

Deposit to acquire plant and equipment	8		4,643,046		-

Intangible asset, net	9		246,726		244,417


Total assets		$	199,762,934	$	159,399,101

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Short term loans	11	$	30,633,889	$	21,204,700
Accounts payable			269,879		736,667
Other payables			2,406,534		2,314,966
Accrued expenses			584,726		522,304
Taxes payable			4,424,434		72,289
Due to an employee			360,000		360,000
Due to related parties	10		1,949,889		1,769,145
Deferred revenue			6,537		77,397
Dividends payable			792,060		792,120

Total current liabilities			41,427,948		27,849,588
Other liabilities
Deferred income tax liabilities - non-current	12		21,755,246		21,525,274
Common stock warrant purchase liabilities	13,14		3,020,058		5,719,130
Embedded conversion feature liabilities	13		364		905

Total other liabilities			24,775,668		27,245,309

Total liabilities			66,203,616		55,094,897

Series C convertible redeemable preferred stock: 2 shares issued and outstanding
as of June 30, 2011 and December 31, 2010	13		1,829		1,829

Commitments and contingencies	19

Stockholders' equity

Series B Preferred Stock, $0.0001 par value, 50,000,000 shares authorized,
1,000,000 shares issued and outstanding as of June 30, 2011 and December 31, 2010	16		100		100
Common Stock, $0.0001 par value, 500,000,000 shares authorized, 47,628,367
shares issued and outstanding as of June 30, 2011 and December 31, 2010	16		4,762		4,762
Additional paid-in-capital			69,318,833		69,040,386
Retained earnings			51,153,023		24,866,352
Statutory surplus reserve fund			6,919,145		6,919,145
Accumulated other comprehensive income			6,161,626		3,471,630

Total stockholders' equity			133,557,489		104,302,375

Total liabilities and stockholders' equity		$	199,762,934	$	159,399,101

The accompanying notes are an integral part of these condensed consolidated financial statements

CHINA XD PLASTICS COMPANY LIMITED

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


		For the Six Months Ended June 30,						For the Three Months Ended June 30,
	Note	2011			2010			2011			2010


Sales		$	164,332,409		$	112,047,102		$	88,194,119		$	62,010,671

Cost of sales			(123,781,159	)		(85,345,782	)		(66,147,271	)		(47,206,057	)

Gross profit			40,551,250			26,701,320			22,046,848			14,804,614
			24.68%			23.83%			25.00%			23.87%
Operating expenses
Research and development expenses	2		5,327,807			3,344,188			3,043,910			1,839,016
Selling expenses			439,744			213,205			256,127			121,826
General and administrative expenses			3,131,981			16,704,288			1,682,107			14,803,282
Total operating expenses			8,899,532			20,261,681			4,982,144			16,764,124

Operating income (loss)			31,651,718			6,439,639			17,064,704			(1,959,510	)

Other income (expenses)
Interest expenses, net			(794,859	)		(683,303	)		(448,398	)		(277,264	)
Other income			98,629			45,611			94,384			39,050
Other expense			(234	)		(17,498	)		(181	)		(1,261	)
Changes in fair value of warrants and embedded derivatives	13,14		2,699,613			4,408,886			2,158,156			(712,768	)
Total other income (expenses)			2,003,149			3,753,696			1,803,961			(952,243	)

Income (loss) before income taxes			33,654,867			10,193,335			18,868,665			(2,911,753	)

Provision for income taxes	12		(7,368,136	)		(67,351	)		(4,488,056	)		(44,619	)

Net income (loss)		$	26,286,731		$	10,125,984		$	14,380,609		$	(2,956,372	)

Other comprehensive income
Foreign currency translation adjustment			2,689,996			545,510			1,510,092			527,865

Comprehensive income (loss)		$	28,976,727		$	10,671,494		$	15,890,701		$	(2,428,507	)

Net income (loss)	18	$	26,286,731		$	10,125,984		$	14,380,609		$	(2,956,372	)

Dividend to Series C preferred stockholders	18	$	(60	)	$	(2,723,337	)	$	(30	)	$	(162,421	)

Net income (loss) attributable to common stockholders	18		26,286,671			7,402,647			14,380,579			(3,118,793	)

Basic and diluted earnings (loss) per common share
Basic	18	$	0.55		$	0.17		$	0.30		$	(0.07	)
Diluted	18	$	0.52		$	0.14		$	0.30		$	(0.07	)

Weighted average common share outstanding
Basic	18		47,737,651			41,879,104			47,548,367			43,503,930
Diluted	18		47,828,321			42,314,977			47,548,367			43,503,930

The accompanying notes are an integral part of these condensed consolidated financial statements

CHINA XD PLASTICS COMPANY LIMITED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


	For the Six Months Ended June 30,
	2011			2010

Cash flows from operating activities
Net income	$	26,286,731		$	10,125,984
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,415,153			1,654,318
Deferred income tax benefits		(229,880	)		-
Stock-based compensation expense		278,447			14,546,859
Change in fair value of warrants and derivative liabilities		(2,699,613	)		(4,408,886	)
Gain on disposals of property, plant and equipment		(13,879	)		(24,210	)
Changes in assets and liabilities:
(Increase) decrease in -
Restricted cash		-			(8,790,261	)
Notes receivables		(150,911	)		110,160
Accounts receivable and other receivables		(1,067,809	)		(9,796,539	)
Prepaid expenses		(2,103	)		27,398
Inventories		6,589,219			(7,251,562	)
Advances to employees		79,224			147,178
Advances to suppliers		(3,076,902	)		(3,435,512	)
Taxes receivable		(217,975	)		(163,321	)
Increase (decrease) in -
Accounts payable and other payables		(616,253	)		10,949,088
Due to an employee		-			360,000
Accrued expenses		53,899			(433,007	)
Taxes payable		4,300,783			1,967
Deferred revenue		(71,693	)		7,376,768

Net cash provided by operating activities		31,856,438			10,996,422

Cash flows from investing activities
Deposits to acquire land use rights and construction in progress		(12,680,373	)		-
Deposits to acquire plant and equipment		(4,589,888	)		-
Purchase of property, plant and equipment		(361,698	)		(255,188	)
Proceeds from sales of property, plant and equipment		40,531			324,014

Net cash (used in) provided by investing activities		(17,591,428	)		68,826

Cash flows from financing activities
Dividends paid on Series C preferred stock		(120	)		(1,621,433	)
Proceeds from short term bank loan		30,283,168			-
Repayment of short term loans		(21,412,341	)		(1,172,035	)
Proceeds from bank acceptance notes		-			5,860,174
Repayment to related parties loan		-			(556	)
Proceeds from related parties loan		255,147			508,289

Net cash provided by financing activities		9,125,854			3,574,439

Effect of exchange rate changes on cash and cash equivalents		748,455			142,204

Net increase in cash and cash equivalents		24,139,319			14,781,891

Cash and cash equivalents, beginning of period		22,720,766			6,850,784

Cash and cash equivalents, end of period	$	46,860,085		$	21,632,675

Supplemental disclosures of cash flow information:

Interest paid	$	815,992		$	664,519
Income taxes paid	$	3,664,701		$	88,981

Non-cash investing and financing activities:
Embedded conversion feature reclassified to equity upon conversion	$	-		$	15,495,392
Preferred stock converted to common stock	$	-		$	13,889,648
Stock options/ restricted shares granted	$	278,447		$	14,546,859
Acquisition of property, plant and equipment	$	542,234		$	255,188
Less: cash paid		(361,698	)		(255,188	)
Non-cash investing activities	$	180,536		$	-

The accompanying notes are an integral part of these condensed consolidated financial statements

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 1. ORGANIZATION AND BASIS OF PRESENTATION

China XD Plastics Company Limited (“China XD Plastics” or the “Company”), formerly known as NB Telecom, Inc. (“NB Telecom”), was originally incorporated as NB Payphones Ltd. under the laws of the state of Pennsylvania on November 16, 1999. On December 27, 2005, we migrated our state of organization to the state of Nevada and effective March 23, 2006, the name was changed to NB Telecom.

On December 24, 2008, NB Telecom acquired all of the outstanding capital stock of Favor Sea Limited (“Favor Sea (BVI)”), a British Virgin Islands corporation, whose assets, held through its subsidiaries, are 100% of the registered capital of Harbin Xinda Macromolecule Material Co., Ltd. (“Harbin Xinda”), a limited liability company established under the laws of the People’s Republic of China (“China” or “PRC”) and Harbin Xinda’s former wholly-owned subsidiary, Harbin Xinda Macromolecule Material Research Institute (the “Research Institute”). Harbin Xinda is engaged in the development, manufacture and marketing of modified plastics, primarily for use in the automotive industry. Harbin Xinda’s offices and manufacturing facilities are located in China.

·	In connection with the acquisition, the following transactions took place:

China XD Plastics issued 10 shares of the common stock which constituted no more than a 10% ownership interest in China XD Plastics and 1,000,000 shares of convertible Series A preferred stock of China XD Plastics to the shareholders of Favor Sea (BVI), as well as 1,000,000 shares of Series B preferred stock to XD Engineering Plastics Company Limited (“XD Engineering”), a British Virgin Islands corporation, the principal shareholder of Favor Sea (BVI), in exchange for all of the outstanding stock of Favor Sea (BVI) (the “Share Exchange” or “Merger”). The 10 shares of the common stock were converted into approximately 50,367,778 shares of the common stock of NB Telecom prior to and approximately 405,802 shares post a reverse stock split of 124.1 for 1 pursuant to Nevada Revised Statutes Section 78.207 for both the total number of authorized shares of common stock and the total number of issued and outstanding shares of common stock (“Reverse Split”). The 1,000,000 shares of convertible Series A preferred stock of NB Telecom shall convert at a rate of approximately 1:38.2 into 38,194,072 shares of the common stock of NB Telecom after the completion of the merger so that the shareholders of Favor Sea (BVI) own approximately 99% of the common stock of China XD Plastics.

The record date for the Reverse Split was set for December 31, 2008. The record holders of NB Telecom’s common stock on the date of December 31, 2008 were subject to a 124.1:1 Reverse Split with fractional shares to be rounded up to one hundred round lots, with the round-up shares to be deducted from certain designated shareholders by NB Telecom.

·	In connection with the acquisition of Favor Sea (BVI), former officers and directors of NB Telecom resigned and executive officers of Favor Sea (BVI) were appointed as China XD Plastic’s new officers and directors.

·	As part of the Merger, the name of the company was changed from NB Telecom to China XD Plastics.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 1. ORGANIZATION AND BASIS OF PRESENTATION (Continued)

As a result of these transactions, the shareholders of Favor Sea (BVI) own a majority of the equity in China XD Plastics.

The acquisition was accounted for as a reverse merger under the purchase method of accounting since there had been a change of control. Accordingly, Favor Sea (BVI) and its subsidiaries are treated as the continuing entities for accounting purposes.

Favor Sea (BVI) was incorporated under the laws of the British Virgin Islands on May 2, 2008.

On August 11, 2008, Favor Sea (BVI) acquired a 100% interest in Hong Kong Engineering Plastics Company Limited (“HK Engineering Plastics”), a limited liability company incorporated under the laws of the Hong Kong Special Administrative Region on May 27, 2008.

Favor Sea (US) Inc. (“Favor Sea (US)”), wholly owned by Favor Sea (BVI), was incorporated in the state of New York in the U.S. on December 15, 2008.

HK Engineering Plastics, in turn, owns 100% interest of Harbin Xinda, a company established in the PRC on September 23, 2004.

China XD Plastics, through its indirectly owned subsidiary, Harbin Xinda, is primarily engaged in the business of research and development, manufacture, and distribution of modified and engineering plastic pellets used in automotive parts through its manufacturing facility and its former wholly owned research laboratory, the Research Institute, a separate entity established in the PRC on November 9, 2007 and deregistered in December 2010.

In June 2010, China XD Plastics, through its indirectly owned subsidiary, Harbin Xinda, invested RMB 20 million (approximately $3 million) to establish a new subsidiary under the laws of the PRC, Harbin Xinda Macromolecule Material Engineering Center Co., Ltd. (“Engineering Center”). Engineering Center performs research and development functions to support the Company’s manufacturing facilities with 35,000 metric tons newly installed production capacity in December 2010, located at Qinling Road, Harbin, China.

In October 2010, China XD Plastics, through its indirectly owned subsidiary, Engineering Center, invested RMB 2 million (approximately $0.3 million) to establish a new subsidiary under the laws of the PRC, Heilongjiang Xinda Software Development Co., Ltd. (“Software Development”). Software Development is engaged in technology consulting and software development in order to better serve the needs of the Company’s existing and potential future customers.

In December 2010, China XD Plastics, through its indirectly owned subsidiary, Harbin Xinda, invested RMB 3 million (approximately $0.5 million) to establish a new subsidiary under the laws of the PRC, Harbin Xinda Macromolecule Material Research Center Co., Ltd. (“Material Research Center”). Material Research Center performs research and development functions to support the Company’s manufacturing facilities with 100,000 metric production capacity located at Dalian North Road, Harbin, China and works to meet the standards of a National Enterprise Technology Center.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 1. ORGANIZATION AND BASIS OF PRESENTATION (Continued)

In December 2010, our management determined that the Research Institute could not meet the Company’s development needs, such as meeting the standards to be a National Enterprise Technology Center. China XD Plastics, through its indirectly owned subsidiary, Harbin Xinda, deregistered the Research Institute under the laws of the PRC. On December 8, 2010, Harbin Daoli District Science and Technology Bureau (“STB”) approved the deregistration application of the Research Institute and its liquidation process in accordance with relevant registration regulations set by the Bureau of Civil Affairs (Note 12).

In March 2011, China XD Plastics, through its indirectly owned subsidiary, Harbin Xinda, invested RMB 3 million (approximately $0.5 million) to establish a new subsidiary under the laws of the PRC, Harbin Xinda Macromolecule Materials Testing Technical Co., Ltd ("Testing Technical"). Testing Technical performs testing services for macromolecule material and engineering plastics products to provide the technical support for the Company.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operating results for the six months ended June 30, 2011 and 2010 are not necessarily indicative of the results that may be expected for the full year. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis and the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements for the six months ended June 30, 2011 and 2010 include the accounts of China XD Plastics, Favor Sea (BVI), Favor Sea (US), HK Engineering Plastics, Engineering Center and Harbin Xinda. The consolidated financial statements for the six months ended June 30, 2011 also include the accounts of Software Development, Material Research Center and Testing Technical. The consolidated financial statements for the six months ended June 30, 2010 also included the accounts of Research Institute. They are collectively referred to as the “Company”. The Company’s consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”). All significant inter-company balances and transactions are eliminated in consolidation.

Use of Estimates

In preparing the financial statements in conformity with US GAAP, management is required 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 financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Significant estimates, required by management, include share-based compensation and fair value of derivatives. Actual results could differ from those estimates.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Cash and Cash Equivalents

For purposes of the statement of cash flows, the Company considers all highly liquid investments with a maturity date of three months or less when purchased to be cash equivalents. The Company did not have any cash equivalents at June 30, 2011 and December 31, 2010. As of June 30, 2011 and December 31, 2010, the Company placed RMB denominated bank deposits equivalent to USD 46,575,060 and USD 21,886,085, respectively, with financial institutions in the PRC. As of June 30, 2011 and December 31, 2010, the Company placed US dollar denominated bank deposits of USD 78,283 and USD 74,924, respectively with a financial institution in the U.S. In addition, As of June 30, 2011 and December 31, 2010, the Company placed US dollar denominated bank deposits of USD 197,157 and USD 725,626 with financial institutions in the PRC.

Accounts Receivable

Accounts receivable consist primarily of receivables resulting from sales of products, and are recorded at the invoiced amount and do not bear interest.

Allowance for Doubtful Receivables

The Company recognizes an allowance for doubtful receivables for estimated losses resulting from the inability of its customers to make required payments. Allowance for doubtful receivables is determined based on a variety of factors, including the length of time the receivables are past due, significant one-time events and historical collection experience. An additional allowance for individual accounts is recorded when the Company becomes aware of a customer’s or other debtor’s inability to meet its financial obligation, such as in the case of bankruptcy filings or deterioration in the customer’s or other debtor’s operating results or financial position. If circumstances related to customers or debtors change, estimates of the recoverability of receivables would be further adjusted (See Note 3).

Inventories

Inventories are stated at the lower of cost or market with cost determined by the weighted average method. Inventories comprise raw materials, packing materials, work-in-progress, and finished goods. Management periodically compares the cost of inventories with the market value and an allowance is made to write down the inventories to their respective market values, if lower than cost. No allowance for inventories was considered necessary for the six months ended June 30, 2011 and 2010.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and locations for its intended use. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Management estimates that property, plant and equipment have a 5% residual value. The estimated useful lives are as follows:-

	Plant and buildings	39 years
	Machinery, equipment and automobiles	5-10 years

An appropriate proportion of the depreciation of property, plant and equipment attributable to manufacturing activities is capitalized as part of the cost of inventory, and expensed in cost of sales when the inventory is sold. Costs incurred in the construction of property, plant and equipment, including an allocation of interest expense incurred, are capitalized and transferred into their respective asset category when the assets are ready for their intended use, at which time depreciation commences.

Expenditure for maintenance and repairs is charged to expense as incurred. Additions, renewals and betterments are capitalized.

Assets under construction are not depreciated until construction is completed and the assets are ready for their intended use.

The gain or loss on disposal of property, plant and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets, and, if any, is recognized in the statement of income and other comprehensive income.

Advances to Suppliers

Advances to suppliers represent payments made and recorded in advance for goods and services supplied. The Company makes advance payments to raw materials suppliers. In order to maintain a long-term relationship with the suppliers, the Company frequently makes advance payments from one and a half months to three months ahead. The advances to suppliers were $35,735,868 and $31,937,098 as of June 30, 2011 and December 31, 2010, respectively.

Impairment of Long-lived Assets

Long-lived assets, which include property, plant and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the assets. If the carrying amounts of assets exceed their estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amounts of the assets exceed the fair value of the assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. No impairment loss was recorded for the six months ended June 30, 2011 and 2010, respectively.

Intangible Asset

Intangible asset consists of land use right which is stated at cost less amortization. Amortization is computed using the straight-line method, based on the period over which the right is granted by the relevant authorities in Heilongjiang Province, PRC. Amortization expense was recorded in general and administrative expenses.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Based Compensation

The Company accounts for stock-based compensation arrangements using the fair value method in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 718 “Compensation-Stock Compensation”. FASB ASC 718 requires that the fair value of share awards issued, modified, repurchased or cancelled after implementation, under share-based payment arrangements, is measured as of the date the award is issued, modified, repurchased or cancelled. The resulting cost is then recognized in the statement of income and comprehensive income over the service period.

The Company estimates fair value of restricted stock based on the number of shares granted and the quoted price of the Company’s common stock on the date of grant.

The fair value of stock options and warrants is estimated using the Black-Scholes option-pricing model. For grants with the expected terms beyond the Company’s trading history, the Company’s expected volatility assumption is based on similar public entities for which share and option price information is available, and the historical volatilities of those public entities’ share prices are considered in calculating the expected volatility appropriate to the Company. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

The Company measures compensation expense for its non-employee stock-based compensation under FASB ASC 718. The fair value of the stock issued is used to measure the transaction, as this is more reliable than the fair value of the services received. Fair value is measured as the value of the Company’s common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty’s performance is complete. The fair value of the equity instrument is charged directly to compensation expense.

Stock compensation expense recognized is based on awards expected to vest. FASB ASC 718 requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those estimates. The current options outstanding were only issued to founders and senior executives of the Company, which have very low turnover; therefore, there are no estimated forfeitures for these options.

Derivative Financial Instruments

Derivative financial instruments are accounted for under FASB ASC 815 “Derivatives and Hedging”. Under FASB ASC 815, all derivative instruments are recorded on the balance sheet as assets or liabilities and measured at fair value. Changes in the fair value of derivative instruments are recorded in current earnings.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes

The Company accounts for income taxes under SFAS No.109 "Accounting for Income Taxes", which is now codified as FASB ASC 740 "Income Taxes". Under FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

FASB ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and it prescribes a recognition threshold and measurement attributable for the financial statements recognition and measurement of a tax position taken or expected to be taken in a tax return. FASB ASC 740 also provides guidance on derecognizing, classification, interest and penalties, accounting in interim periods, disclosures and transitions. Interest and penalties from tax assessments, if any, are included in general and administrative expenses in the consolidated statement of income and comprehensive income.

The Company recognizes that virtually all tax positions in the PRC are not free of some degree of uncertainty due to tax law and policy changes by the PRC government. However, the Company cannot reasonably quantify political risk factors and thus must depend on guidance issued by current PRC government.

Based on all known facts and circumstances and current tax law, the Company believes that the total amount of unrecognized tax benefits as of June 30, 2011 and December 31, 2010 is not material to its results of operations, financial condition or cash flows. The Company also believes that the total amount of unrecognized tax benefits as of June 30, 2011, if recognized, would not have a material effect on its effective tax rate. The Company further believes that there are no tax positions for which it is reasonably possible, based on current Chinese tax law and policy, that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the Company’s results of operations, financial condition or cash flows.

The new Enterprise Income Tax Law (“EIT”) and its implementation rules in the PRC impose a withholding income tax at 10%, unless reduced by a tax treaty/arrangement, for dividends distributed by a PRC-resident enterprise to its immediate holding company outside the PRC for earnings accumulated beginning on January 1, 2008. Undistributed earnings generated prior to January 1, 2008 are exempt from such withholding income tax. Under the terms of a tax treaty between Hong Kong and the PRC that became effective in December 2006, distributions from Harbin Xinda to HK Engineering Plastics will be subject to a withholding tax at a rate of 5%. Further, the Company’s distribution from its PRC subsidiaries are subject to the U.S. federal income tax at 34%, less any applicable qualified foreign tax credits. The Company has not recognized any deferred income tax liability for the undistributed earnings generated by the PRC subsidiaries as the Company plans to indefinitely reinvest these earnings in the PRC.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue Recognition

The Company’s revenue recognition policies are in compliance with FASB ASC 605 “Revenue Recognition”. In accordance with FASB ASC 605, revenues are recognized when the four following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the delivery is completed, (iii) the fees are fixed or determinable, and (iv) collectability is reasonably assured.

Revenue from sales of products is recognized when the products are considered delivered when they reach the customers’ location and are accepted by customers, which is the point when the customers take ownership and assume risk of loss, and when collectability is reasonably assured. The Company does not provide its customers with the right of return. However, the Company allows for an exchange of products or return if the products are defective. For the periods presented, defective product returns were immaterial. All sales are based on firm customer orders with fixed terms and conditions, which generally cannot be modified.

Revenue is recognized net of value added tax (“VAT”). Enterprises or individuals who sell commodities, engage in repairs and maintenance or import or export goods in the PRC are subject to VAT in accordance with the PRC laws. The VAT standard rate is 17% of the gross sales price. A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products can be used to offset the VAT due on the sales of the finished products.

Revenue from the technology services that are generally sold based upon purchase orders or contracts with the customers with fixed or determinable prices does not include any right of return or other similar provisions or other significant post-delivery obligations. Revenue for services is recognized as the services are rendered and when collectibility is reasonably assured.

Cost of sales

Costs of sales are comprised principally of costs of raw materials, packing materials, labor, utilities, depreciation and write-down of inventory to lower of cost or market.

Selling, general and administrative expenses

Selling expenses consist primarily of costs of payroll, benefits, commissions for sales representatives and outbound freight and advertising expense.

General and administrative expenses are comprised principally of payroll and benefits costs for administrative employees, rent and operating costs of office premises, depreciation and amortization, and other administrative expenses.

Outbound freight, which is cost incurred to physically move product from the Company’s premises to the premises designated by the customers, is classified as selling expenses. Handling costs, which are costs incurred to store, move and prepare products for shipment, are classified as cost of sales. $254,996 and $91,434 of outbound freight were classified in selling expenses for the six months ended June 30, 2011 and 2010.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Research and Development Expenses

Research and development expenses are costs associated with developing the Company’s intellectual property. Research and development costs are expensed as incurred. The costs of equipment that are acquired or constructed for research and development activities and have alternative future uses are classified as plant and equipment and depreciated over their estimated useful lives The research and development expenses for the six months ended June 30, 2011 and 2010 were $5,327,807 and $3,344,188, respectively. The research and development expenses for the three months ended June 30, 2011 and 2010 were $3,043,910 and $1,839,016, respectively.

Fair Value of Financial Instruments

FASB ASC 825 “Financial Instruments” requires disclosing fair value to the extent practicable for financial instruments that are recognized or unrecognized in the balance sheet. The fair value of the financial instruments disclosed herein is not necessarily representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences of realization or settlement.

The carrying amounts of certain financial instruments, including cash and cash equivalents, accounts receivable, notes and other receivables, accounts payable, accrued expenses and other payables approximate fair value due to the short-term nature of these items. The carrying amounts of short-term loans from bank approximate the fair value based on the Company's expected borrowing rate for debt with similar remaining maturities and comparable risk.

Fair Value Measurement

FASB ASC 820 “Fair Value Measurements and Disclosures” introduces a framework for measuring fair value and expands required disclosure about fair value measurements of assets and liabilities. FASB ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

There are three levels of inputs that may be used to measure fair value:

Level 1 -

Quoted prices in active markets for identical assets or liabilities.

Level 2 -

Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 -

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

As of June 30, 2011 and December 31, 2010, the Company determines the fair value of the derivative liabilities associated with the issuances of the Series C preferred stock and direct offering of common shares with the assistance of an independent third party valuation firm. We use an option-pricing model that incorporates the Company’s stock price and risk-free interest rate as well as assumptions regarding a number of highly complex and subjective variables, which includes but is not limited to the Company’s expected stock price volatility over the term of the derivative liabilities.

Assets and liabilities measured at fair value on a recurring basis are summarized below:


	As of June 30, 2011
Description	Total		Level 1		Level 2		Level 3
	US$		US$		US$		US$

Common stock warrant purchase liabilities		3,020,058		-		3,020,058		-

Embedded conversion feature liabilities		364		-		364		-

Total		3,020,422		-		3,020,422		-


	As of December 31, 2010
Description	Total		Level 1		Level 2		Level 3
	US$		US$		US$		US$

Common stock warrant purchase liabilities		5,719,130		-		5,719,130		-

Embedded conversion feature liabilities		905		-		905		-

Total		5,720,035		-		5,720,035		-

Earnings per Share

The Company computes earnings per share (“EPS’) in accordance with FASB ASC 260 “Earnings Per Share”. FASB ASC 260 requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as net income divided by the weighted average common shares outstanding for the period.

Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options and warrants) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

Comprehensive Income

In accordance with ASC 220, “Comprehensive Income” which requires disclosure of all components of comprehensive income and loss on an annual and interim basis, comprehensive income and loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated other comprehensive income arose from the changes in foreign currency exchange rates.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Comprehensive income is comprised of net income (loss) and other comprehensive income. Other comprehensive income includes foreign currency translation adjustments due to the exchange rate fluctuations from transactions denominated in Chinese RMB, the functional currency of our subsidiaries in China, which is different than the US dollar, which is our reporting currency.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of cash, accounts and notes receivable. The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews of its customers' financial condition and customer payment practices to minimize collection risk on accounts receivable. As of June 30, 2011 and December 31, 2010, the Company had credit risk exposure of uninsured cash in banks of approximately $46,860,085 and $22,720,766, respectively.

Risks and Uncertainties

The Company’s operations in the PRC are subject to special consideration and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.

Foreign Currency Translation

The functional currency of the Company is US dollars, Renminbi (“RMB”) is the functional currency of its subsidiaries in China, and its reporting currency is U.S. dollars. In accordance with FASB ASC 830 “Foreign Currency Matters”, the subsidiaries in China’s balance sheet accounts are translated into U.S. dollars at the year-end or period end exchange rates and all revenue and expenses are translated into U.S. dollars at the average exchange rates prevailing during the periods in which these items arise. Translation gains and losses are deferred and accumulated as a component of other comprehensive income in stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations from transactions denominated in a currency other than the functional currency are included in the consolidated statement of income and comprehensive income as incurred. These amounts were immaterial for all the periods presented. For the six months ended June 30, 2011 and 2010, the Company recorded a gain of $2,689,996 and $545,510 on foreign currency adjustments, respectively, due to appreciation of the RMB against the US Dollar. For the three months ended June 30, 2011 and 2010, the Company recorded a gain of $1,510,092 and $527,865 on foreign currency adjustments, respectively, for the same reason.

The PRC government imposes significant exchange restrictions on fund transfers out of the PRC that are not related to business operations. These restrictions have not had a material impact on the Company because it has not engaged in any significant transactions that are subject to the restrictions.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Segment Reporting

The Company has only one operating segment. All customers are located in the PRC. The majority of assets are located in the PRC. No segment reporting disclosure has been made.

Profit Appropriation

In accordance with PRC regulations, the PRC subsidiaries are required to make appropriations to the statutory surplus reserve fund, based on after-tax net income determined in accordance with PRC GAAP. Appropriation to the statutory surplus reserve fund should be at least 10% of the after-tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entity’s registered capital. Statutory surplus reserve fund is non-distributable other than in liquidation.

Recent Accounting Pronouncements

In June 2011, the FASB issued Accounting Standard Update (“ASU”) 2011-05, Comprehensive income (Topic 220), Presentation of Comprehensive Income. ASU 2011-05 increases the prominence of other comprehensive income in financial statements. Under this ASU, an entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The ASU eliminates the option in U.S. GAAP to present other comprehensive income in the statement of changes in equity. An entity should apply the ASU retrospectively. For a public entity, the ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this ASU will only affect the presentation of comprehensive income and will not change the composition or calculation of comprehensive income.

Note 3. ACCOUNTS RECEIVABLE

Accounts receivable consists of trade receivables resulting from sales of products during the normal course of business. Accounts receivable as of June 30, 2011 and December 31, 2010 amounted to $30,723,563 and $28,615,995, respectively.

The Company collaborates directly with its end users on new product development, product certifications and post-sales support. Sales contracts are usually signed directly between the Company and its end users. However, due to the nature of this industry, the Company also regularly uses distributors to sell its products to various end users. This arrangement with distributors can greatly assist to ensure timely collections of Company accounts receivable and reduce the Company’s selling and administrative costs. The Company believes that all of the accounts receivable outstanding from these distributors are collectible (See Note 17).

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 3. ACCOUNTS RECEIVABLE (Continued)

The changes in allowance for doubtful receivables are summarized as follows:

	As of
	June 30, 2011		December 31, 2010
	US$		US$

Beginning balance		33,136		166,095
Additions (Deduction)		13,916		(132,959	)

Ending balance		47,052		33,136

The changes in allowance for doubtful receivables are recorded in general and administrative expenses.

Note 4. INVENTORIES

Inventories consist of the following:

	As of
	June 30, 2011		December 31, 2010
	US$		US$

Raw materials		13,012,127		10,665,068
Work-in-progress		65,386		935,282
Finished goods		5,998,387		13,632,381
Packing supplies		57,723		24,352
Total		19,133,623		25,257,083

No allowance for inventories was made for the six months ended June 30, 2011 and 2010.

Note 5. ADVANCES TO EMPLOYEES

Advances to employees represent motor vehicle loans and cash advances to employees to purchase raw materials or equipment and other supplies for normal business purposes. Advances to employees as of June 30, 2011 and December 31, 2010 amounted to $444,740 and $559,546, respectively.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 6. PROPERTY, PLANT AND EQUIPMENT, NET

The details of property, plant and equipment are as follows:

	As of
	June 30, 2011			December 31, 2010
	US$			US$

Machinery and equipment		47,352,823			46,259,596
Automobiles		132,462			169,987
Plant and buildings		4,138,680			4,025,178
Sub-total		51,623,965			50,454,761
Less: accumulated depreciation		(8,642,404	)		(6,088,372	)

Construction in progress		5,190,851			4,671,714
Total		48,172,412			49,038,103

Certain property, plant and equipment have been pledged for short term loans (See Note 11).

Note 7. DEPOSIT TO ACQUIRE LAND USE RIGHTS AND CONSTRUCTION IN PROGRESS

On May 9, 2011, Harbin Xinda, a subsidiary of Company, entered into a land use rights and construction project purchase agreement (the “Land and CIP Purchase Agreement”) with Harbin Shengtong Engineering Plastics Co. Ltd. (“Harbin Shengtong”), pursuant to which Harbin Xinda purchased from Harbin Shengtong the land use rights to an aggregate of 198,895.7 square meters located in South Harbin Industrial Park, PRC (the “Property”), and the construction project currently in progress on the Property (the “Project”), for an aggregate purchase price of RMB 94,997,800 (approximately USD 14,698,716), including RMB 75,845,800 (approximately USD 11,735,386) for the transfer of the land use rights and RMB 19,152,000 (approximately USD 2,963,330) for the construction in progress already present on the Property, to be paid in three installments upon the completion of certain milestones detailed below. Harbin Xinda has also paid RMB 7,062,100 (USD 1,091,844) management fees to Harbin Shengtong, which is repayable by Harbin Shengtong if the construction does not meet Harbin Xinda’s expectation.

Subsequent to the signing of the Land and CIP Purchase Agreement, on June 1, 2011, Harbin Xinda entered into a Cooperation Agreement (the “Cooperation Agreement”) with Harbin Shengtong, pursuant to which the parties confirmed their specific rights and obligations with respect to the Property and the Project, including, among other things, that Harbin Shengtong will manage the construction of the new buildings comprising the Project in accordance with Harbin Xinda’s construction plans, design requirements and budget, as more fully set forth in the Agreement. After the completion of the Project, and after Harbin Xinda completes its Project inspection for acceptance, Harbin Shengtong shall transfer the land use rights and the ownership of the buildings contained on the Property to Harbin Xinda.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 7. DEPOSIT TO ACQUIRE LAND USE RIGHTS AND CONSTRUCTION IN PROGRESS (Continued)

The total cost of the land use rights and Project is approximately RMB 435,000,000 (approximately USD 67,306,205), which includes: (i) RMB 75,845,800 (approximately USD 11,735,386) for the transfer of the land use rights (see above), which was already paid as deposit, (ii) the total cost of RMB 350,000,000 (approximately USD 54,154,417) including RMB 19,152,000 (approximately USD 2,963,330) for the construction in progress already present on the Property and completion of the construction of the Project, and (iii) a construction management fee of RMB 10,000,000 (approximately USD 1,547,269).

As of June 30, 2011, the Company had paid a deposit to Harbin Shengtong of RMB 82,907,900 (equivalent to USD 12,827,230), including RMB 75,845,800 (equivalent to USD 11,735,386) for the land use rights, and RMB 7,062,100 (equivalent to USD 1,091,844) for the management fees for the initial phase of the Project.

Note 8. DEPOSIT TO ACQUIRE PLANT AND EQUIPMENT

On June 13, 2011, the Company, through its subsidiary, Material Research Center (“Purchaser”) entered into an equipment purchase contract with Harbin Jiamu Import and Export Trading Co., Ltd. (“Seller”), pursuant to which, Harbin Xinda will purchase various equipment for RMB 278,043,900 (equivalent to approximately $43,020,873). The equipment is expected to be delivered by September 30, 2011. The Company agreed to make a 30% deposit of the total purchase price by July 31, 2011.

As of June 30, 2011, the Company has made a deposit of RMB 30,010,000 (equivalent to USD 4,643,046) for purchasing the equipment. (See Note 19).

Note 9. INTANGIBLE ASSET

Intangible asset consists of land use right only. All land in the PRC is government owned and cannot be sold to any individual or company. Instead, the government grants the user a land use right (“the Right”) to use the land.

The Company has the right to use the land for 50 years and amortizes the Right on a straight-line basis over the remaining useful life of 48 years from 2007 to 2055. The Right was originally acquired in May 2005 for the amount of $226,281.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 9. INTANGIBLE ASSET (Continued)

Net intangible asset as of June 30, 2011 and December 31, 2010 was as follows:

	As of
	June 30, 2011			December 31, 2010
	US$			US$

Land use right		282,533			276,590
Less: accumulated amortization		(35,807	)		( 32,173	)
Total		246,726			244,417

Amortization expense, recorded in general and administrative expenses, amounted to $2,910 and $2,787 for the six months ended June 30, 2011 and 2010, respectively. Amortization expenses for the next five years are estimated to be approximately $5,700 each year. The land use right has been pledged for short term loans (See Note 11).

Note 10. RELATED PARTY TRANSACTIONS

Amounts due to (+) and due from (-) affiliates are as follows:

	As of
	June 30, 2011		December 31, 2010
	US$		US$
Harbin Xinda High-Tech Co., Ltd. (“Xinda High-tech)		180,744		(75,732	)
Ms. Qiuyao Piao (“Ms. Piao”)		1,769,145		1,769,145
Total		1,949,889		1,693,413

Prior to the reverse merger, Ms. Piao owned 100% of Favor Sea (BVI) indirectly via XD Engineering, the former sole shareholder of Favor Sea (BVI). Xinda Hi-Tech is an affiliated company owned by the spouse of Mr. Han, who was the major shareholder of Harbin Xinda before the ownership was transferred to HK Engineering Plastics.

On September 20, 2008, Harbin Xinda signed an agreement with Xinda High-Tech to acquire all of the assets of Xinda High-Tech, including plant and buildings, land use rights, machinery and equipment for a total amount of RMB 240,000,000 (approximately USD 35,136,006 at date of signing). Harbin Xinda was required to make two installment payments of the full purchase price of RMB 50,000,000 by the end of December 31, 2008 and the remaining balance of RMB 190,000,000 by the end of September 30, 2009 if all assets purchased are transferred to the Company. On May 1, 2009, Harbin Xinda and Xinda High-Tech agreed to rescind the agreement.

Prior to signing of the above-mentioned agreement, the Company rented the buildings and equipment of Xinda High-Tech for the purpose of its production expansion. The lease term was from May 1, 2008 to April 30, 2011. The lease payment was for a total of RMB 2,000,000 per year. The lease contract was cancelled when Harbin Xinda and Xinda High-Tech rescinded the agreement on May 1, 2009 and at the same time, Harbin Xinda and Xinda High-Tech re-signed a new lease agreement for the office and factory space at No. 9 Dalian North Road, Haping Road Centralized District, Harbin Development Zone, Harbin, Heilongjiang, China. The leased space is 23,893.53 square meters and the term of the lease is from May 1, 2009 to April 30, 2012. The lease payment remains at RMB 2,000,000 per year. In the six months ended June 30, 2011 and 2010, the Company recorded $152,945 and $146,505 respectively, for the rent expenses.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 10. RELATED PARTY TRANSACTIONS (Continued)

On May 18, 2010, Engineering Center signed an agreement with Xinda High-Tech to rent an office building from Xinda High-Tech located at No. 9 Dalian North Road, Haping Road Centralized District, Harbin Development Zone, Harbin, Heilongjiang, China. The lease term was from June 1, 2010 to May 31, 2013, with lease space of 2,801.19 square meters. The lease payment is RMB 200,000 per year. In the six months ended June 30, 2011 and 2010, the Company recorded $15,295 and $2,549 for the rent expenses, respectively.

Ms Piao, Qiuyao, the majority owner of XD Engineering Plastic as of June 30, 2011, advanced to the Company $1,769,145 which represents a U.S. dollar denominated interest free loan provided by Ms. Piao to fund the Company’s working capital. The loan is unsecured and does not have specific terms of repayment and was recorded as due to related party as of June 30, 2011 and December 31, 2010, respectively. HK Engineering Plastics intends to repay the loan by the end of 2011.

Note 11. SHORT TERM LOANS

The short-term loans include the following:

	As of
	June 30, 2011		December 31, 2010
	US$		US$
a) Loan payable to Bank of Communications one year term from December 13, 2010 to April 26, 2011 bears interest of 5% above the prime rate* set by Central Bank of China		-		1,514,622
b) Loan payable to Bank of Communications one year term from April 28, 2010 to April 26, 2011 bears interest rate of 5% above the prime rate* set by Central Bank of China		-		4,543,864
c) Loan payable to Longjiang Bank one year term from February 22, 2010 to February 21, 2011 bears a fixed interest rate of 5.441% per year		-		4,543,864
d) Loan payable to Longjiang Bank one year term from February 22, 2010 to February 21, 2011 bears a fixed interest rate of 5.441% per year		-		4,543,864
e) Loan payable to Longjiang Bank one year term from May 25, 2010 to February 21, 2011 bears a fixed interest rate of 5.441% per year		-		3,029,243
f) Loan payable to Longjiang Bank one year term from April 29, 2010 to February 21, 2011 bears a fixed interest rate of 5.441% per year		-		3,029,243
g) Loan payable to Bank of Communications one year term from January 13, 2011 to January 13, 2012 bears interest at the prime rate* set by Central Bank of China		9,282,997		-
h) Loan payable to Bank of Communications one year term from January 18, 2011 to January 18, 2012 bears interest at the prime rate* set by Central Bank of China		6,188,665		-
i) Loan payable to Longjiang Bank one year term from March 8, 2011 to March 7, 2012 bears a fixed interest rate of 6.06% per year		4,641,498		-
j) Loan payable to Longjiang Bank one year term from March 8, 2011 to March 7, 2012 bears a fixed interest rate of 6.06% per year		7,735,831		-
k) Loan payable to Longjiang Bank one year term from April 29, 2011 to April 20, 2012 bears a fixed interest rate of 6.31% per year		773,583
l) Loan payable to Longjiang Bank one year term from April 29, 2011 to April 20, 2012 bears a fixed interest rate of 6.31% per year		2,011,315
Total		30,633,889		21,204,700

* The prime rate set by Central Bank of China as of June 30, 2011 was 6.31% (December 31, 2010: 5.81%).

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 11. SHORT TERM LOANS (Continued)

The one-year short term loan of $9,282,997 and $6,188,665 between Harbin Xinda and Bank of Communications is secured by Xinda High-Tech’s pledge of certain of its machinery and guaranteed by Mr. Han and his wife.

The one-year short term loan of $4,641,498 between Harbin Xinda and Longjiang Bank for the period from March 8, 2011 to March 7, 2012 is secured by Materials Research Centre’s pledge of certain of its machinery.

The one-year short term loan of $7,735,831 between Harbin Xinda and Longjiang Bank for the period from March 8, 2011 to March 7, 2012 is secured by Harbin Xinda’s pledge of certain of its machinery.

The one-year short term loan of $773,583 between Harbin Xinda and Longjiang Bank for the period from April 29, 2011 to April 20, 2012 is secured by Harbin Xinda’s pledge of certain of its land use right.

The one-year short term loan of $2,011,315 between Harbin Xinda and Longjiang Bank for the period from April 29, 2011 to April 20, 2012 is secured by Harbin Xinda’s pledge of certain of its land use right and buildings.

Interest expense for the Company’s short term loans totaled $815,992 and $664,519 for the six months ended June 30, 2011 and 2010, respectively.

Note 12. TAXATION

(a) Corporation Income Tax (“CIT”)

No provision for income tax for China XD Plastics and Favor Sea (US) has been made as they incurred losses for the six months ended June 30, 2011 and 2010.

HK Engineering Plastics’ income is subject to taxation in Hong Kong at 16.5%. No provision for Hong Kong income tax has been made as HK Engineering Plastics has had no assessable profit since its incorporation.

Favor Sea (BVI) is not subject to income tax in any tax jurisdiction.

The subsidiaries operating in the PRC are subject to income taxes as described below:-

Under the EIT, effective January 1, 2008, a uniform tax rate of 25% is applicable to both domestic and Foreign Investment Enterprises.

Harbin Xinda was granted high-tech enterprise status from January 1, 2008 to November 20, 2011. A high-technology enterprise is entitled to a preferential income tax rate of 15%. Upon the renewal of the certificate of high-tech enterprise by November 20, 2011, the Company will be able to apply the preferential income tax rate of 15% from January 1, 2011 to December 31, 2013.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 12. TAXATION (continued)

Income for Engineering Center, Material Research Center, Software Development and Testing Technical are subject to a 25% statutory tax rate under the current tax laws in the PRC. Income for Research Institute was exempt from taxation.

For the six months ended June 30, 2011 and 2010, the current and deferred components of the income tax expense appearing in the consolidated statements of income and comprehensive income are as follows:

	2011		2010
	US$		US$
Current tax		7,598,016		67,351
Deferred tax		(229,880)		-
Total		7,368,136		67,351

The following table reconciles the statutory rates to the Company’s effective tax rate for the six months ended June 30, 2011 and 2010:

	2011			2010
PRC statutory rate		25.00	%		25.00	%
Effect of tax rates in different jurisdiction		0.50	%		35.06	%
Effect of non-deductible expenses		0.34	%		3.33	%
Effect of non-taxable income		(3.41	%)		(14.70	%)
Changes in valuation allowance		0.65	%		2.79	%
Effect of tax exemption of PRC subsidiaries		(3.29	%)		(50.73	%)
Underprovision in prior year		2.10	%

Effective income tax rate		21.89	%		0.66	%

(b) Deferred Tax

As of June 30, 2011 and December 31, 2010, China XD Plastics and Favor Sea (US) had accumulated net operating loss carryforwards for United States federal tax purposes of approximately $2,639,759 and $1,991,527, respectively, that are available to offset future taxable income. Realization of the net operating loss carryforwards is dependent upon future profitable operations. In addition, the carryforwards may be limited upon a change of control in accordance with Internal Revenue Code Section 382, as amended. Accordingly, management has recorded a valuation allowance to reduce deferred tax assets associated with the net operating loss carryforwards to zero at June 30, 2011 and December 31, 2010. The net operating loss carryforwards expire in years 2027 through 2030.

In December 2010, due to the Research Institute’s ineligibility to meet standards of National Enterprise Technology Center, China XD Plastics, through its indirectly owned subsidiary, Harbin Xinda, deregistered the Research Institute under the laws of the PRC., Simultaneous with the completion of the Research Institute liquidation process, the local government approved the Research Institute’s transfer of its remaining assets of RMB 568,466,136 (USD 83,990,741) at their carrying amount to the Material Research Center, which is treated as a government grant and the amount of RMB 568,466,136 (USD 83,990,741) was recorded as other income.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 12. TAXATION (Continued)

Pursuant to the Notice on Corporate Tax Treatment on Special Purpose Fiscal Fund” issued by Ministry of Finance and National Taxation Bureau on June 16, 2009 (Ref Caishui 2009 (87)), the government grant received by Material Research Center is non-taxable in the year of grant. Moreover, if the government grant is not expensed or refunded to the government within five years (60 months), it is taxable in the sixth (6th) year from the year of grant. As a result, the government grant received by the Material Research Center is non-taxable income for the year ended December 31, 2010. It will be taxable effective from December 29, 2015 if it is not expensed or refunded to government within five (5) years.

The Company analyzed the transactions in accordance with ASC740-10-25-26, and recorded a deferred tax liability in respect of the temporary difference arising from the non-taxable government grant recognized in the current year and the non-deductible amounts in future years.

As of June 30, 2011, the movement of deferred tax assets (+) /deferred tax liabilities (-) consists of:

	June 30, 2011
	US$
Balance as of January 1, 2011		(21,525,274	)
Deferred tax credit		229,880
Exchange difference		(459,852	)

Net operating loss carry forwards		897,518	)
Less: valuation allowance		(897,518

Balance of June 30, 2011, Net		(21,755,246	)

General business tax of 5% is levied on technology service revenue.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK

On December 1, 2009, China XD Plastics entered into a securities purchase agreement with several investors, including institutional, accredited and non-US person and entities, pursuant to which China XD Plastics sold units, comprised of 6% Series C convertible redeemable preferred stock, par value $0.0001 per share (the “Series C preferred stock”), and two warrants, for a purchase price of $4.60 per unit (the “December 2009 Financing”). The Company sold 15,188 units in the aggregate, which included (i) 15,188 shares of Series C preferred stock, (ii) Series A warrants to purchase 1,320,696 shares of common stock at an exercise price of $5.50 per share with a five-year term, and (iii) Series B warrants to purchase 1,178,722 shares of common stock at an exercise price of $0.0001 with a five-year term. Net proceeds were approximately $13,891,477, net of issuance costs of approximately $719,400 in cash and warrants to the placement agent valued at $577,123. Rodman & Renshaw acted as placement agent and received (i) a placement fee in the amount equal to 5% of the gross proceeds and (ii) warrants to purchase up to 117,261 shares of common stock at an exercise price of $5.50, with a five-year term (“Placement Agent Warrants” and together with the Series A warrants and Series B warrants, the “Warrants” or “Investor Warrants”).

Key terms of the Series C preferred stock sold by the Company in December 2009 Financing are summarized as follows:

Dividends

Dividends on the Series C preferred stock shall accrue and be cumulative from and after the issuance date. For each outstanding share of Series C preferred stock, dividends are payable at the per annum rate of 6% of the liquidation preference amount of the Series C preferred stock. Dividends are payable quarterly on the business day following the last business day of each December, June, and September of each year and continuing until such stock is fully converted or redeemed. Preferred stock holders are entitled to convert any unpaid dividends per preferred stock then remaining, into fully paid and nonassessable shares of common stock at a mutually agreed conversion rate.

Voting Rights

The Series C preferred stock holders are entitled to vote separately as a class on matters affecting the Series C preferred stock and with regard to certain corporate matters set forth in the Series C Certificate of Designation, so long as any shares of the Series C preferred stock remain outstanding. Holders of the Series C preferred stock are not, however, entitled to vote on general matters along with holders of common stock.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK (Continued)

Liquidation Preference

In the event of a liquidation event, the holders of the Series C preferred stock then outstanding shall be entitled to receive in cash out of the assets of the Company available for distribution to its stockholders, an amount equal to $1,000 per share of the Series C preferred stock, plus any accrued but unpaid dividends thereon, whether or not declared, together with any other dividends declared but unpaid thereon, as of the date of liquidation before any payment shall be made or any assets distributed to the holders of the common stock or any other junior stock. If upon the occurrence of liquidation, the assets thus distributed among the holders of the Series C preferred stock shall be insufficient to permit the payment to such holders of the full Series C preferred stock amount, then the entire assets of the Company legally available for distribution shall be distributed ratably among the holders of the Series C preferred stock.

Conversion Rights

i) Voluntary Conversion

At any time on or after the date of the initial issuance of the Series C preferred stock, the holder of any such shares of Series C preferred stock may, at such holder’s option, convert any whole number of preferred shares, plus the amount of any accrued but unpaid dividends per preferred share then remaining, into fully paid and nonassessable shares of common stock at the initial conversion price of $4.60 per share. The initial conversion price may be adjusted for stock splits and combinations, dividend and distributions, reclassification, exchange or substitution, reorganization, merger, consolidation or sales of assets as stimulated in the Certification of Designation.

ii) Mandatory Redemption

If any preferred shares remain outstanding on the maturity date of December 1, 2012, the Company shall redeem such preferred shares in cash in an amount equal to the outstanding conversion amount for each such preferred share (See “Accounting for the Series C Preferred Stock” below).

Conversion Restriction

Holders of the Series C preferred stock may not convert the preferred stock to common stock if the conversion would result in the holder beneficially owning more than 4.99% of the Company’s outstanding shares of common stock. That limitation may be waived by a holder of the Series C preferred stock and an increase or decrease in the maximum percentage to any other percentage not in excess of 9.99% may be specified in such notice by sending a written notice to the Company on not less than 61 days prior to the date that they would like to waive the limitation.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK (Continued)

Registration Rights Agreement

In connection with the December 2009 Financing, the Company entered into a registration rights agreement (the “RRA”) with the investors in which the Company agreed to file a registration statement (the “Registration Statement”) with the SEC to register the shares of common stock underlying the Series C preferred stock and the Warrants, thirty (30) days after the closing of the financing. The Company has agreed to use its best efforts to have the Registration Statement declared effective within 60 calendar days after filing, or 180 calendar days after filing in the event Cutback Shares (as defined in the RRA) are required and the additional Registration Statement is required to cover additional Registrable Securities.

The Company is required to keep the Registration Statement continuously effective under the Securities Act until such date as is the earlier of the date when all of the securities covered by that Registration Statement have been sold or the date on which such securities may be sold without any restriction pursuant to Rule 144 (the “Financing Effectiveness Period”). The Company will pay liquidated damages of 2% of each holder’s initial investment in the Units sold in the December 2009 Financing, payable in cash, if the Registration Statement is not filed or declared effective within the foregoing time periods or ceases to be effective prior to the expiration of the Financing Effectiveness Period. In the event the Company fails to make payments of liquidated damages in a timely manner, such payments shall bear interest at the rate of one and one-half percent (1.5%) per month (prorated for partial months) until paid in full. However, no liquidated damages shall be paid with respect to any securities being registered that the Company is not permitted to include in the Financing Registration Statement due to the SEC’s application of Rule 415.

The Company evaluated the contingent obligation related to the RRA liquidated damages in accordance with FASB ASC 825-20 “Financial Instruments”, which requires the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, to be separately recognized and measured in accordance with FASB ASC 450 “Contingencies”. The Company concluded that such obligation was not probable to incur based on the best information and facts available as of December 31, 2009. Therefore, no contingent obligation related to the RRA liquidated damages was recognized.

The Company’s Registration Statement filed with the SEC in connection with the issuance of Series C preferred stock was declared effective on February 19, 2010.

The Series C preferred stock is mandatorily redeemable on December 1, 2012, at a conversion amount equal to the stated value plus the additional amount. The additional amount is a formula based on the 6% dividend rate at the time that the preferred stock is outstanding. The Company used the guidance of FASB ASC 480-10-S99, “Distinguishing Liabilities from Equity” which states that equity instruments with redemption features that are not solely within the control of the issuer to be classified temporary equity. The Company’s Series C preferred stock is contingently redeemable as it is convertible until the end of the third anniversary.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK (Continued)

As of June 30, 2011, 15,186 out of total 15,188 shares of Series C preferred stock were converted into 3,301,300 shares of common stock. No conversion took place during the six months ended June 30, 2011.

Dividend to Holders of Series C Preferred Stock

During the six months ended June 30, 2011 and 2010, the Company has made cash dividend payments of $120 and $1,621,433 to the holders, respectively.

In 2010, several holders of Series C preferred stock elected to receive their dividend payments in the form of restricted common stock in connection with their conversion of all their Series C preferred shares pursuant to the provisions in the Certification of Designation of Series C Preferred Stock. The total common shares issued in 2010 were 26,827.

Embedded Conversion Feature

FASB ASC 815 indicates that an embedded conversion feature should be considered to be a derivative if the following criteria are met:

i) The economic characteristics and risks differ between the host and embedded conversion feature. This condition, relative to our Series C preferred stock, is met because the preferred stock has a mandatory redemption feature at the discretion of the holders instead of the Company. Hence, the conversion feature is not clearly and closely related to the economic characteristics of the host contract. The embedded derivative (that is, the conversion option) must be separated from its host contract and accounted for as a derivative liability provided that the conversion option would, as a freestanding instrument, be a derivative instrument.

ii) The contract that includes the host and the conversion feature is not re-measured at fair value. This condition is met because the contract (Series C preferred stock) is not to be re-measured at fair value.

iii) A separate instrument with the same terms as the embedded conversion feature would be derivative as per paragraph 6 of FASB ASC 815. Our review of paragraph 6 revealed that the embedded conversion feature without a host would be considered a derivative because the embedded conversion feature (1) has underlying and notional amounts, (2) requires no initial net investments and (3) permits net settlement.

Based on the above considerations, the embedded conversion feature related to our Series C preferred stock is a derivative that must be bifurcated from the host instrument and accounted for at fair value with changes in fair value recorded in earnings.

During the six months ended June 30, 2010, 15,186 out of 15,188 shares Series C preferred stock were converted into 3,301,300 shares of common stock. The conversion resulted in a fair value gain of $3,082,922 recorded in earnings and a credit of $15,495,392 to additional paid-in capital. No conversion took place during the six months ended June 30, 2011.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK (Continued)

The Company calculated the fair value of the embedded conversion feature at June 30, 2011 to be $364 using the Black-Scholes option pricing model using the following assumptions:

·	conversion price of $4.6

·	risk free rate of return of 0.32%

·	volatility of 52.03%

·	dividend yield of 6.0%

·	expected term of 1.4 years

The movements of embedded conversion feature are summarized as follows:

	US$
Issuance of preferred stock on December 1, 2009		16,812,682

Adjustment to fair value change		1,985,377

Balance as of December 31, 2009 and January 1, 2010		18,798,059

Conversion of preferred stock to common shares		(10,150,803	)

Adjustment to fair value change upon conversion		(8,644,782	)
Adjustment to fair value change		(1,569	)
Balance as of December 31, 2010 and January 1, 2011		905
Adjustment to fair value change		(541)
Balance as of June 30, 2011		364

Accounting for Warrants

The Warrants have an initial exercise price which is subject to adjustments in certain circumstances for stock splits, combinations, dividends and distributions, reclassification, exchange or substitution, reorganization, merger, consolidation or sales of assets, issuance of additional shares of common stock or equivalents. The Warrants may not be exercised if it would result in the holder beneficially owning more than 4.99% of the Company’s outstanding common shares.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK (Continued)

The Company analyzed the Warrants in accordance with FASB ASC 815 to determine whether the Warrants meet the definition of a derivative and, if so, whether the Warrants meet the scope exception of FASB ASC 815, which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity shall not be considered to be derivative instruments for purposes of FASB ASC 815.

The Company also considered the provisions of FASB ASC 815-40 which applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by FASB ASC 815 and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.

As a result of its interpretation of FASB ASC 815-40, the Company concluded that the Warrants issued in the December 2009 financing should be treated as a derivative liability because the Warrants are entitled to a price adjustment provision to allow the exercise price to be reduced in the event the Company issues or sells any additional shares of common stock at a price per share less than the then-applicable exercise price or without consideration, which is typically referred to as a “Down-round protection” or “anti-dilution” provision. According to FASB ASC 815-40, the “Down-round protection” provision is not considered to be an input to the fair value of a fixed-for-fixed option on equity shares which leads the Warrants to fail to be qualified as indexed to the Company’s own stock and then to fail to meet the scope exceptions of FASB ASC 815. Therefore, the Company accounted for the Warrants as derivative liabilities under FASB ASC 815. Pursuant to FASB ASC 815, derivatives are measured at fair value and re-measured at fair value with changes in fair value recorded in earnings at each reporting period.

Series A warrants

On October 4, 2010, the Company issued 3,333,334 shares of common stock and warrants to purchase a total of 1,666,667 shares of common stock to investors pursuant to a registered direct offering (see Note 14). In accordance with the above “down-round protection” provision, the Company had an independent valuation firm to appraise the fair value of the Series A Warrants that were outstanding to determine the appropriate adjustment to the exercise price. The exercise price of the Series A Warrants was adjusted to $4.90 in accordance with the provisions in the Purchase Agreement for financial reporting purpose.

The Company estimated the fair value of the Series A warrants at June 30, 2011 to be $2,593,673 compared to the fair value of $3,915,133 as of December 31, 2010, with the assistance of an independent valuation firm, using the Black-Scholes option-pricing model and the following assumptions:

·	exercise price of $4.9

·	risk free rate of return of 1.02%

·	volatility of 72.2%

·	dividend yield of 0%

·	expected term of 3.4 years

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK (Continued)

The volatility of 72.2 % used to calculate the fair value of Series A warrants and placement agent warrants was determined based on similar public entities for which share price information is available for a longer period than that of our own shares.

Series B warrants

The Series B warrants were not valued at the date of the agreement because the stock price on the two reset dates, which further depend on the effectiveness of registration statement, will not be known until the Price Reset Date. The Series B warrants expired on June 10, 2010 and no reset took effect.

Placement Agent Warrants

In accordance with Staff Accounting Bulletin Topic 5.A: “Miscellaneous Accounting-Expenses of Offering” (FASB ASC 340-10-S99-1), specific incremental costs directly attributable to a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering. In accordance with the SEC Accounting and Reporting Manual, “costs of issuing equity securities are charged directly to equity as deduction of the fair value assigned to shares issued.” Accordingly, the Company concluded that the Placement Agent Warrants are directly attributable to the December 2009 Financing. If the Company had not issued the Placement Agent Warrants, the Company would have had to pay the same amount of cash as the fair value. Therefore, the Company deducted the total fair value of the Placement Agent Warrants as of the commitment date, which was approximately $577,123, against the gross proceeds.

Since the Placement Agent Warrants contain the same terms as the Investor Warrants, the Placement Agent Warrants are also entitled to the benefits of the “Down-round protection” provisions, which means that the Placement Agent Warrants will also need to be accounted for as a derivative under FASB ASC 815 with changes in fair value recorded in earnings at each reporting period. As of June 30, 2011, the total fair value of the Placement Agent Warrants was $215,881, compared to the fair value of $329,637 as of December 31, 2010.

The registered holders of the Investor and Placement Agent Warrants are entitled to exercise their warrants at any time or times on or after the date immediately after the six month anniversary until the sixty month anniversary after the issuance date.

The Company estimated the fair value of the Placement Agent Warrants as of June 30, 2011 with the assistance of an independent valuation firm using the Black-Scholes option-pricing model and the following assumptions:

·	exercise price of $5.5

·	risk free rate of return of 1.02%

·	volatility of 72.2%

·	dividend yield of 0%

·	expected term of 3.4 years

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 13. SERIES C CONVERTIBLE REDEEMABLE PREFERRED STOCK (Continued)

The movement of common stock warrant purchase liabilities is summarized as follows:

		Series A warrants US$			Placement Agent warrants US$			Total US$
Issuance of common stock warrants on December 1, 2009	$	6,500,059		$	577,123		$	7,077,182

Adjustment to fair value change		748,844			66,487			815,331

Balance as of December 31, 2009 and January 1, 2010		7,248,903			643,610			7,892,513

Adjustment to fair value change		(3,333,770	)		(313,973	)		(3,647,743	)

Balance as of December 31, 2010 and January 1, 2011		3,915,133			329,637			4,244,770
Adjustment to fair value change		(1,321,460	)		(113,756	)		(1,435,216	)
Balance as of June 30, 2011	$	2,593,673		$	215,881		$	2,809,554

Allocation of proceeds on December 1, 2009

The fair value of the embedded conversion feature and warrants of $23,312,741 was recorded as follows:-

i)	the Company recorded a deemed preferred stock dividend of $13,891,477;
ii)	the excess of the fair values of the embedded conversion feature and warrants over the net proceeds received of $9,421,264 was charged to changes in fair value of warrants and embedded derivatives in the statement of income and comprehensive income.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 14. COMMON STOCK DIRECT OFFERING

On October 4, 2010, the Company and certain institutional investors entered into a securities purchase agreement, pursuant to which the Company agreed to sell to such investors an aggregate of 3,333,334 shares of common stock together with warrants to purchase a total of 1,666,667 shares of common stock, for gross proceeds of approximately $20,000,000. Each purchaser of shares of common stock received a warrant to purchase a number of shares equal to 50% of the number of shares of common stock the purchaser purchased in the offering. The purchase price for each share of common stock and the related warrant was $6.00. Each warrant has an exercise price of $6.00. Each warrant is subject to anti-dilution provisions that require adjustment of the number of shares of common stock that may be acquired upon exercise of the warrant, or to the exercise price of such shares, or both, to reflect stock dividends and splits, subsequent rights offerings, pro-rata distributions, and certain fundamental transactions.

Rodman & Renshaw acted as placement agent and received (i) a placement fee in the amount equal to 5% of the gross proceeds from the sale of shares of common stock and related warrants in this offering, plus ii) warrants to purchase 166,667 shares of common stock. The placement agent warrants are on substantially the same terms as the purchaser warrants except that the placement agent warrants have an exercise price equal to $7.50 per share, and an exercise period ending on July 6, 2013. The Company also reimbursed the Placement Agent for all out-of-pocket expenses incurred in connection with the offering, which was limited to the lesser of 0.8% of the gross proceeds raised by the Company or $25,000.

In connection with the offering, the Company and certain holders of the Company’s series C convertible preferred stock entered into an amendment agreement, dated as of September 30, 2010, to the securities purchase agreement dated November 27, 2009 among the Company and the purchasers of the Company’s series C convertible preferred stock, pursuant to which the parties agreed to amend such purchasers’ right to participate in future financings of the Company to exclude from this participation right the registered direct offering.

The closing date of the offering was on October 8, 2010. 3,333,334 shares of the Company’s common stock and related warrants were issued to several institutional investors at $6 each for gross proceeds of $20,000,000. Net proceeds after issuance cost were approximately $18,821,504.

The shares of common stock, warrants to purchase common stock, and shares of common stock issuable upon exercise of the warrants were issued pursuant to a prospectus supplement filed with the SEC in connection with a takedown from the Company’s shelf registration statement on Form S-3 (File No. 333-167423), which was declared effective by the SEC on July 6, 2010.

Accounting for Warrants Relevant to October 2010 Direct Offerings

The Company analyzed the warrants in accordance with FASB ASC 815, as described above. As a result of its interpretation of FASB ASC 815-40, the Company concluded that the warrants issued in the October 2010 direct offering should be treated as a derivative liability because the warrants are entitled to a net cash settlement provision if the Company fails to cause the transfer agent to timely transmit to the holder a certificate or certificates representing the shares of common stock upon exercise pursuant to the clause “Compensation for Buy-In on Failure to Timely Deliver Certificates Upon Exercise”. Pursuant to FASB ASC 815, derivatives are measured at fair value and re-measured at fair value with changes in fair value recorded in earnings at each reporting period.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 14. COMMON STOCK DIRECT OFFERING (Continued)

The Company estimated the fair value of the warrants using the Black Scholes option-pricing model and available information that management deems most relevant.

Investor Warrants

The Company estimated the fair value of investor warrants at June 30, 2011 to be $99,008 compared to the fair value of $1,127,768 as of December 31, 2010, with the assistance of an independent valuation firm using the Black-Scholes option-pricing model and the following assumptions:

·	exercise price of $6

·	risk free rate of return of 0.04%

·	volatility of 50.0%

·	dividend yield of 0%

·	expected term of 0.3 years

Placement Agent Warrants

The Company estimated the fair value of placement agent warrants at June 30, 2011 to be $111,496 compared to the fair value of $346,592 as of December 31 2010, with the assistance of an independent valuation firm using the Black-Scholes option-pricing model using the following assumptions:

·	exercise price of $7.5

·	risk free rate of return of 0.46%

·	volatility of 59.3%

·	dividend yield of 0%

·	expected term of 2.02 years

The volatility used to calculate the fair value of investor and placement agent warrants was determined based on similar public entities for which share price information is available for a longer period than that of our own shares.

Allocation of Proceeds

The following summarized the allocation of $18,821,504 net proceeds to the common stock and the Warrants:

i)	Investor Warrant: $3,664,722

ii)	Placement Agent Warrant: $506,320

iii)	Common Stock: $14,650,462

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 14. COMMON STOCK DIRECT OFFERING (Continued)

The movement of common stock warrant purchase liabilities is summarized as follows:

		Investor warrants US$		Placement Agent warrants US$		Total US$
Issuance of common stock warrants on October 4, 2010	$	3,664,722	$	506,320	$	4,171,042

Adjustment to fair value change		(2,536,954)		(159,728)		(2,696,682)

Balance as of December 31, 2010 and January 1, 2011		1,127,768		346,592		1,474,360

Adjustment to fair value change		(1,028,760)		(235,096)		(1,263,856)

Balance as of June 30, 2011	$	99,008	$	111,496	$	210,504

Note 15. STOCK-BASED COMPENSATION

The Company adopted the 2009 Stock Incentive Plan (the “2009 Plan”) on May 26, 2009, which reserved 7,800,000 shares of common stock for issuance. The 2009 Plan allows the Company to issue awards of incentive non-qualified stock options and stock bonuses to directors, officers, employees and consultants of the Company, which may be subject to restrictions. The Company applied FASB ASC 718 and related interpretations in accounting for the 2009 Plan. Compensation for services that a corporation receives under FASB ASC 718 through share-based compensation plans should be measured by the quoted market price of the stock at the grant date less the amount, if any, that the individual is required to pay.

Stock compensation expense recognized is based on awards expected to vest. The fair value of the stock compensation is amortized over the respective vesting period based on the terms of the employment or service agreements under which the stock was awarded.

The fair value of the stock-based compensation expense amortized for the six months ended June 30, 2011 and 2010 was $278,447 and $1,191,027, respectively.

Incentive Option Granted to Mr. Han

Pursuant to an incentive option agreement dated May 16, 2008, Ms. Piao granted 40,000 Options to Mr. Han to purchase shares of XD Engineering Plastics Company Limited (“XD Engineering”) at a nominal price if certain performance targets are met. Ms. Piao was the sole shareholder of XD Engineering, which is the Company’s controlling shareholder. Mr. Han may purchase 25% of the total outstanding equity in XD Engineering if the Company’s consolidated revenue during the first three quarters of 2008 exceeds $40,000,000. He may purchase 14% of the total outstanding equity in XD Engineering if the Company’s consolidated revenue during the first three quarters of 2009 exceeds $70,000,000. Finally, he may purchase 61% of the total outstanding equity in XD Engineering if the Company’s revenue during the first three quarters of 2010 exceeds $110,000,000.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 15. STOCK-BASED COMPENSATION (Continued)

In accordance with ASC Topic 718, the Options should be accounted for in the Company’s consolidated financial statements as share-based payments awarded to an employee by a related party as compensation for services rendered.

All the revenue targets have been achieved from 2008 to 2010 and the corresponding compensation expenses have been fully recognized as of December 31, 2010.

During the six months ended June 30, 2011 and 2010, $-0- and $13,355,832 stock compensation expense was recorded.

On February 23, 2010 and July 5, 2011, Mr. Han exercised his option to acquire 250 shares, or 25% and 750 shares or 75% of the total outstanding equity in XD Engineering respectively, at the determined exercise price.

Stock Options Issued to Employees and Directors

On August 7, 2010, the Company’s compensation committee granted 445,500 options to purchase shares of the Company’s common stock to two directors and certain executive officers and employees. One-third (1/3) of the options will vest yearly on a calendar basis over a three-year period commencing on the date of grant. The exercise price shall be the greater of (i) $8.01 or (ii) 85% of the fair market value as determined under the Company’s stock option plan on the date of the grant. One-third (1/3) of the options will expire on each August 7, 2011, August 7, 2012 and August 7, 2013, respectively.

The fair value of stock options granted was estimated at the date of grant with the assistance of an independent valuation firm using the Black-Scholes option-pricing model with the following assumptions: expected life of 1, 2 and 3 years for each one-third (1/3) of the options, expected volatility 64.4%, 83.9%, and 75.8%; risk free interest rate 0.29%, 0.51%, and 0.73%, respectively, and same exercise price of $8.01 and same dividend yields of 0.00%.

Following is a summary of the stock option activity:

	Number of Options Outstanding		Weighted Average Exercise Price US$		Weighted Average Fair Value US$	Aggregate Intrinsic Value US$
Balance as of December 31, 2010		445,500		8.01	2.24	-
Outstanding as of June 30, 2011		445,500		8.01	2.24	1,692,900
Exercisable as of June 30, 2011		-		-	-	-
Unvested as of June 30, 2011		445,500		8.01	2.24	1,692,900

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 15. STOCK-BASED COMPENSATION (Continued)

During the six months ended June 30, 2011, compensation expense of $164,757 (2010: $Nil) was recognized.

The aggregate intrinsic value in the table above represents the total intrinsic value (i.e., the difference between the Company’s closing stock price of $4.21 on June 30, 2011 and the exercise price, multiplied by the number of options) that would have been received by the option holders had all option holders exercised their options on June 30, 2011. None of the options vested during the year. The weighted average remaining contractual term of the outstanding options at June 30, 2011 was 2 years.

As of June 30, 2011, $699,245 of total unrecognized compensation cost related to stock options is expected to be recognized over 2.17 years.

On August 7, 2010, the Company’s compensation committee granted 99,856 shares of restricted stock to its four (4) independent directors, two directors and certain executive officers and employees. The restricted shares issued were granted for their services rendered to the Company. The shares issued to independent directors vest six (6) months after the issuance date and three (3) years for a director and certain executive officers and employees.

A summary of the restricted stock unit activity is as follows:

	Restricted Stock Units		Weighted- Average Grant Date Price per Share		Aggregated Fair Market Value

Balance at December 31, 2010		99,856	$	6.57	$	656,054

Vested		(19,856)		6.57		(130,454)
Balance at June 30, 2011 (granted but not yet vested)		80,000		6.57		525,600

As of June 30, 2011, 5,444,620 share-based awards were available for grant.

Note 16. STOCKHOLDERS’ EQUITY

(a) Common Stock

Issuance of Common Stock

Prior to the reverse merger, China XD Plastics had 49,632,222 shares of common stock issued and outstanding at $.0001 per share. In connection with the reverse merger consummated on December 24, 2008, all of these outstanding shares were subject to a 124.1 for 1 reverse split for all record holders of China XD Plastics’ common stock on the date of December 31, 2008. The number of the post reverse-split of the original common stock outstanding was rounded up to 400,000 shares.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 16. STOCKHOLDERS’ EQUITY (Continued)

In consideration for the merger, China XD Plastics issued 10 shares of its common stock and 1,000,000 shares of convertible Series A preferred stock to the shareholders of Favor Sea (BVI), and also 1,000,000 shares of Series B preferred stock to XD Engineering, the principal shareholder of Favor Sea (BVI). The 10 shares of the common stock issued to shareholders of Favor Sea BVI were converted into approximately 50,367,778 shares of the common stock of China XD Plastics prior to and approximately 405,802 shares post a reverse stock split of 124.1 for 1. The equity account of Favor Sea (BVI), prior to the merger date, has been retroactively restated so that the ending outstanding share balance as of the merger date is equal to the number of post reverse-split shares received in the merger.

As a part of the merger agreement effected on December 24, 2008, 1,000,000 shares of Series A preferred stock were automatically converted into 38,194,072 shares of common stock on April 20, 2009 after China XD Plastics’ effective filing to increase its authorized shares.

On June 5, 2009, China XD Plastics issued 1,790,000 common shares to some employees and consultants as stock compensation in connection with the services rendered or to be rendered in 2009.

Among these shares, 868,000 vested in 2009 and 922,000 vested in 2010.

On September 2, 2009, the Company issued 20,024 common shares to four independent directors in connection with the service agreements between China XD Plastics and the directors. These shares vested in 2010.

On November 16, 2009, a consultant exercised its warrants and received 57,152 shares of common stock.

During the six months ended June 30, 2010, 15,186 shares series C preferred stock were converted into 3,301,300 shares of common stock. No conversion took place during the six months ended June 30, 2011.

On August 7, 2010, the Company’s compensation committee granted 99,856 shares of restricted stock to its four (4) independent directors, two directors, certain executive officers and employees.

On August 7, 2010, the Company’s compensation committee granted 445,500 shares of the Company’s common stock to two directors and certain executive officers and employees. One-third (1/3) of the options will vest yearly on a calendar basis over a three-year period commencing on the date of grant. The exercise price shall be the greater of (i) $8.01 or (ii) 85% of the fair market value as determined under the Company’s stock option plan on the date of the grant.

On October 8, 2010, the Company issued 3,333,334 shares of common stock to investors (see Note 14).

As of June 30, 2011, there were 47,628,367 shares of common stock issued and outstanding.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 16. STOCKHOLDERS’ EQUITY (Continued)

(b) Preferred Stock

There are also 1,000,000 shares of Series B Preferred Stock issued and outstanding, and all of the issued and outstanding shares of Series B Preferred Stock have voting power equal to 40% of the total voting power of all of the issued and outstanding shares of the common stock.

Note 17. SIGNIFICANT CONCENTRATION

Three (3) major vendors provided approximately 94% of the Company’s purchases of raw materials for the six months ended June 30, 2011, with each vendor individually accounting for approximately 34% and 34% and 26%, respectively.

Two (2) major vendors provided approximately 99% of the Company’s purchases of raw materials for the six months ended June 30, 2010, with each vendor individually accounting for approximately 50% and 49%, respectively.

The advances to the vendors were $34,078,219 and $31,771,758 as of June 30, 2011 and December 31, 2010, respectively.

Three (3) major vendors provided approximately 94% of the Company’s purchases of raw materials for the three months ended June 30, 2011, with each vendor individually accounting for 37%, 30% and 27%, respectively. Two (2) major vendors provided approximately 99% of the Company’s purchases of raw materials for the three months ended June 30, 2010, with each vendor individually accounting for 52% and 47%, respectively.

Sales to three major distributors accounted for approximately 61% of the Company’s sales for the six months ended June 30, 2011, with each distributor individually accounting for 35%, 13% and 13%, respectively.

Sales to two major distributors accounted for approximately 70% of the Company’s sales for the six months ended June 30, 2010, with each distributor individually accounting for 58% and 12%, respectively.

Sales to four major distributors accounted for approximately 74% of the Company’s sales for the three months ended June 30, 2011, with each distributor individually accounting for 36%, 13% 13% and 12%, respectively.

Sales to three major distributors accounted for approximately 77% of the Company’s sales for the three months ended June 30, 2010, with each distributor individually accounting for 53%, 13% and 11%, respectively.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 18. EARNINGS (LOSS) PER SHARE

Earnings (loss) per share (“EPS”) information is determined using the two-class method, which includes the weighted-average number of common shares outstanding during the period and other securities that participate in dividends (“participating securities”). Our unvested shares and Series C preferred stock are considered “participating securities” because they include non-forfeitable rights to dividends. In applying the two-class method, earnings are allocated to both common stock shares and participating securities based on their respective weighted-average shares outstanding for the period. Diluted EPS information may include the additional effect of other securities, if dilutive, in which case the dilutive effect of such securities is also calculated using the two-class method. Basic and dilutive earnings per share for the quarter ended March 31, 2010 and for the year ended December 31, 2011 will be reduced by $0.02 per share, respectively.

The following table sets forth the computation of basic EPS for the periods indicated:

		Six Months Ended June 30,						Three Months Ended June 30,
		2011			2010			2011			2010

Numerator
Net income (loss) attributable to China XD	$	26,286,731		$	10,125,984		$	14,380,609		$	(2,956,372	)
Less: Dividend paid
-Series C preferred shares		(60	)		(2,723,337	)		(30	)		(162,421	)
Undistributed earnings		26,286,671			7,402,647			14,380,579			(3,118,793	)
Less:
Earnings allocated to participating Series C preferred shares		(239	)		(253,583	)		(131	)		-

Earnings allocated to participating unvested shares		(46,265	)		(131,685	)		(24,154	)		-

Net income (loss) allocated to common stockholders	$	26,240,167		$	7,017,379		$	14,356,294		$	(3,118,793	)

Denominator:
Weighted average shares of common stock		47,737,651			41,879,104			47,548,367			43,503,930

Basic earnings (loss) per common stock	$	0.55		$	0.17		$	0.30		$	(0.07	)

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 18. EARNINGS (LOSS) PER SHARE (Continued)

The following table sets forth the computation of dilutive EPS for the periods indicated:

	Six Months Ended June 30,						Three Months Ended June 30,
Numerator	2011			2010			2011		2010
Net income (loss) allocated to common stockholders as reported in Basic EPS	$	26,240,167		$	7,017,379		$	14,356,294	$	(3,118,793	)
Changes in fair value of derivative liabilities-Series A investor warrants		(1,321,460	)		(1,017,907	)		-		-

Changes in fair value of derivative liabilities-Series A placement agent warrants		-			(90,377	)		-		-

Net income (loss) allocated to common stockholders	$	24,918,707		$	5,909,095		$	14,356,294	$	(3,118,793	)

Denominator:
Weighted average shares of common stock as reported in Basic EPS		47,737,651			41,879,104			47,548,367		43,503,930
Dilutive effect of Series A investor warrants		90,670			409,428			-		-

Dilutive effect of Series A placement agent warrants		-			26,445			-		-

Weighted average shares of common stock		47,828,321			42,314,977			47,548,367		43,503,930
Dilutive earnings (loss) per common stock	$	0.52		$	0.14		$	0.30	$	(0.07	)

The Company identified a mathematical error in the computation of dilutive earnings per common stock in prior periods' financial statements, in which the Company did not deduct the changes in fair values of warrants from net income attributable to common stockholders for the purpose of calculation of dilutive earnings per common stock. As a result, the presentation of the US GAAP dilutive earnings per common stock for the quarter ended March 31, 2010, December 31, 2010 and March 31, 2011, and for the year ended December 31, 2010 will be reduced by $0.04 per share, $0.05 per share, $0.01 per share and $0.08 per share, respectively. This adjustment only impacted the statement of income below the operating line and is non-cash in nature. It had no effect on total assets, total liabilities, net income or cash flows as previously reported.

The Company had outstanding common stock purchase warrants of 3,271,291 and 1,437,957 as of June 30, 2011 and 2010, respectively. For the six months ended June 30, 2011, the Series A warrants issued to investors in connection with Series C preferred stock were dilutive and included in diluted weighted average share calculation, because the market price was higher than the exercise price. However, the warrants issued to placement agents in connection with Series C preferred stock and Series C warrants and placement agent warrants of the October 2010 direct offering were anti-dilutive and not included in weighted average share calculation because the exercise price was higher than the market price.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 18. EARNINGS (LOSS) PER SHARE (Continued)

For the six months ended June 30, 2010, the Series A warrants issued to investors and the warrants issued to the placement agent in connection with Series C preferred stock were dilutive and included in diluted weighted average share calculation, because the market price was higher than the exercise price.

Note 19. COMMITMENTS AND CONTINGENCIES

Office Rent

As of June 30, 2011, the Company leased buildings, facilities and office buildings in Harbin and the leases will expire from April 30, 2012 to May 31, 2013. Rental expenses for the six months ended June 30, 2011 and 2010 amounted to $168,240 and $146,505, respectively. The rental expenses are included in general and administrative expenses.

As of June 30, 2011, the Company rented an office in the U.S. and the lease will expire on March 30, 2013. Rental expenses for the six months ended June 30, 2011 and 2010 amounted to $37,961 and $48,420, respectively

The future minimum lease payments under the above mentioned leases as of December 31, 2011 are as follows:

Year ending December 31,	US$
2011	$	203,488
2012		202,186
2013		30,043
Total	$	435,717

Capital Contribution

As of June 30, 2011, HK Engineering Plastics had a commitment in respect of capital contribution to Harbin Xinda of approximately $15,236,098 (RMB 98,477,000), which has to be paid by September 2012.

Renovation of Plant Facilities

As of June 30, 2011, the Company had a commitment of $763,221 (RMB 4,933,000) for renovation of plant facilities.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 19. COMMITMENTS AND CONTINGENCIES (Continued)

Acquiring Land Use Rights and Construction in Progress

Pursuant to the Agreement of land use rights and construction project from Harbin Shengtong (See Note 7), the Company has a commitment of paying RMB 352,092,100 (approximately USD 54,478,122) upon the completion of the major buildings of the construction project satisfactory to the Company after the Company accepts, upon its inspection, such buildings and puts them into use. (See Note 7)

Acquiring Plant and Equipment

On June 13, 2011, the Company, through its subsidiary, Materials Research Centre’s (“Purchaser”) entered into an equipment purchase contract (amended on July 10, 2011) with Harbin Jiamu Import and Export Trading Co., Ltd. (“Seller”), pursuant to which, Harbin Xinda will purchase various equipment at a consideration of RMB 278,043,900 (equivalent to USD 43,018,210). The equipment is expected to be delivered by September 30, 2011, and the Company agreed to make the 30% of the total purchase price at RMB 83,413,170 by July 31, 2011 as the deposit, 40% of the total purchase price of RMB 111,217,560 by October 10, 2011 upon the delivery of all equipment, 25% of the total purchase price of RMB 69,510,975 by November 25, 2012, and the retention of 5% of the total purchase price of RMB 13,902,195 by November 25, 2012.

As of June 30, 2011, the Company has paid RMB 30,010,000 (equivalent to USD 4,643,046) to Seller and has a commitment to pay the remaining RMB 248,033,900 (equivalent to USD 38,375,164) according to the above schedule (See Note 8).

Note 20. SUBSEQUENT EVENTS

Raw Materials Purchase

On July 30, 2011, Harbin Xinda entered into two raw material purchase contracts with two suppliers, pursuant to which, Harbin Xinda will purchase a variety of raw materials for RMB 53,820,400 (equivalent to approximately USD 8,326,949).

Notes Payable Contracts

On August 1, 2011, Harbin Xinda entered into a loan contract with Harbin Branch of Xingye Bank pursuant to which, Harbin Xinda was granted a credit line of approximately USD 10,830,213 (RMB 70,000,000,) with an interest rate equal to the prime rate on the day of drawdown, repayable from August 2, 2011 to July 31, 2012 and was guaranteed by Xinda High-Tech and Mr. Han. Harbin Xinda is also required to place a security deposit of 50% of the loan amount with the bank.

On August 2, 2011, Harbin Xinda obtained a note payable of approximately USD 6,188,665 (RMB 40,000,000) pursuant to the above credit line for raw materials purchase. The note term is from August 2, 2011 to February 2, 2012.

On August 8, 2011, Harbin Xinda obtained a note payable of approximately USD 4,641,520 (RMB 30,000,000) pursuant to the above credit line for raw materials purchase. The note term is from August 8, 2011 to February 8, 2012.

CHINA XD PLASTICS COMPANY LIMITED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)

Note 20. SUBSEQUENT EVENTS (Continued)

On August 15, 2011, we 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 Company Limited, our largest shareholder (“XDE”), and Mr. Jie Han, our chairman and Chief Executive Officer (“Mr. Han”). Pursuant to the Securities Purchase Agreement, MSPEA will, subject to the terms and conditions set forth therein, purchase from us 16,000,000 shares (the “Purchased Shares”) of our series D junior convertible preferred stock, par value US$0.0001 per share (the “Series D Preferred Stock”), for an aggregate purchase price of US$100 million.

Also on August 15, 2011, XDE and Mr. Han, the two stockholders of the Company who collectively hold a majority of the combined voting power of our voting securities, adopted resolutions by written consent approving the relevant transaction documents and all transactions contemplated by the transaction documents. Such approval will become effective no earlier than 20 days after an information statement is sent to our stockholders pursuant to Rule 14C of the Securities Exchange Act of 1934, as amended, and is the only stockholder approval required by the Nasdaq Stock Market Listing Rules of the transactions contemplated by the transaction documents.

Item 2. Management’s Discussion and Analysis of Financial Condition and Result 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 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 plastic 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 Plastics”), formerly known as NB Telecom, Inc. (“NB Telecom”) was originally incorporated as NB Payphones Ltd. under the laws of the state of Pennsylvania on November 16, 1999. On December 27, 2005, we migrated our state of organization to the state of Nevada and effective March 23, 2006, our name was changed to NB Telecom.

On December 24, 2008, NB Telecom acquired all of the outstanding capital stock of Favor Sea Limited (“Favor Sea BVI”), a British Virgin Islands corporation, whose assets, held through its subsidiary Hong Kong Engineering Plastics Company Limited (“HK Engineering Plastics”), 100% of the registered capital of Harbin Xinda Macromolecule Material Co., Ltd. (“Harbin Xinda”), a limited liability company established under the laws of the People’s Republic of China (“China” or “PRC”).

Harbin Xinda is a manufacturer and developer of modified plastics. We believe that Harbin Xinda is one of the primary modified plastics manufacturers for automotive applications in the PRC, developing and producing made-to-order modified plastics and providing after-sales services to such automotive brands as Audi, Red Flag, VW Golf, Toyota, BMW, Mazda and Haifei Alternative Energy Vehicle.

Recent Events

Comparing Three Months Ended June 30, 2011 and 2010:

The following table sets forth information from our statements of operations for the three months ended June 30, 2011 and 2010, in dollars:

		Three Months Ended June 30,				$		%
		2011		2010		Change		Change

Cost of Sales	$	(66,147,271	)	(47,206,057	)	(18,941,214	)		40.1	%
Gross Profit		22,046,848		14,804,614		7,242,234			48.9	%
Operating Expenses		(4,982,144	)	(16,764,124	)	(11,781,980)	)		(70.3	)%

Operating Income (Loss)		17,064,704		(1,959,510	)	19,024,214			(970.9	)%

Interest Expenses, net		(448,398	)	(277,264	)	(171,134	)		61.7	%

Other Income, net		94,203		37,789		56,414			149.3	%

Changes in Fair Value of Warrants and Embedded Derivatives		2,158,156		(712,768	)	2,870,924			(402.8	)%

Income Tax Provision		(4,488,056	)	(44,619	)	(4,443,437	)		9,958.66	%

Net Income (Loss)		14,380,609		(2,956,372	)	17,336,981			(586.4	)%

Comprehensive Income (Loss)	$	15,890,701		(2,428,507	)	18,319,208			(754.3.3	)%

Net sales

During the three months ended June 30, 2011, we had net sales of $88,194,119, as compared with net sales of $62,010,671 during the same period in 2010, an increase of $26,183,448, or 42.2%, principally due to approximately 23.5% increase in sales volume and a 15.2% increase in the average selling price of our products. The increase of sales volume was driven by the strong demand of modified plastics in the Chinese market and higher penetration of our business in our traditional 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 prices for plastic resins in general.

Product Mix

The following table presents the breakdown of revenues in millions of US dollars by product mix:

	Revenues
(in millions, except	Three Months Ended June 30,
Percentage)	2011					2010
	Amount		%			Amount		%			Change in Amount		Change in %
Modified Polypropylene (PP)	$	50.79		57.59	%	$	38.78		62.54	%	$	12.01		30.97	%

Engineering Plastics		14.25		16.16	%		10.55		17.01	%		3.70		35.07	%

Modified Polyamide (PA)		6.34		7.19	%		4.02		6.48	%		2.32		57.71	%

Alloy Plastics		5.90		6.69	%		2.87		4.63	%		3.03		105.57	%

Environment Friendly Plastics		5.63		6.38	%		1.72		2.78	%		3.91		227.33	%

Modified Acrylonitrile Butadiene Styrene (ABS)		5.28		5.99	%		4.07		6.56	%		1.21		29.73	%

Total Revenues	$	88.19		100	%	$	62.01		100	%	$	26.18		42.22	%

The following table presents the product mix breakdown by thousands of metric tons (MT) of modified plastics sold to customers.

(in thousands MTs,	Sales Volume
except percentage)	Three Months Ended June 30,
	2011					2010
	MT		%			MT		%			Change in MT		Change in %
Modified Polypropylene (PP)		26,221		71.82	%		22,923		77.53	%		3,298		14.39	%

Engineering Plastics		2,870		7.86	%		2,030		6.86	%		840		41.38	%

Modified Polyamide (PA)		1,417		3.88	%		920		3.11	%		497		54.02	%

Alloy Plastics		1,841		5.04	%		1,158		3.92	%		683		58.98	%

Environment Friendly Plastics		2,410		6.60	%		867		2.93	%		1,543		177.97	%

Modified Acrylonitrile Butadiene Styrene (ABS)		1,754		4.80	%		1,670		5.65	%		84		5.03	%

Total		36,513		100	%		29,568		100	%		6,945		23.49	%

Cost of Sales and Gross Margin

During the three months ended June 30, 2011, we had cost of sales of $66,147,271, as compared with cost of sales of $47,206,057 during the same period in 2010, an increase of approximately $18,941,214, or 40.1%, reflecting the increase in net sales. The gross profit rose to $22,046,848 for the three months ended June 30, 2011, or a 48.9% increase compared with $14,804,614 during the same period in 2010. Our gross margin increased to 25.00% during the three months ended June 30, 2011 from 23.87% during the three months ended June 30, 2010. The increase was mainly attributed to the increased sales of our high-end products as a percentage of total sales in the second quarter of 2011 due to 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 the per-vehicle-basis in China.

Selling Expenses

Our selling expenses increased by $134,301, or 110.2%, to $256,127 for the three months ended June 30, 2011, from $121,826 for the same period of 2010. As a percentage of sales, selling expenses increased from 0.2% for the three months ended June 30, 2010 to 0.3% for the same period of 2011. The increase of selling expenses was primarily due to an increase in advertising and promotion expenses related to marketing and promotional activities in our existing and new geographic markets.

General and Administrative Expenses

Our general and administrative expenses were $1,682,107 during the three months ended June 30, 2011, compared with $14,803,282 during the three months ended June 30, 2010, a decrease of $13,121,175 or approximately 88.6%. The decrease in general and administrative expenses was principally due to the non-cash stock compensation expense of options granted to Mr. Han of $13,355,832 for the three months ended June 30, 2010, as previously disclosed in our Current Report on Form 8-K on April 14, 2010.

Research and Development Expenses

Research and development expenses were $3,043,910 during the three months ended June 30, 2011 compared with $1,839,016 during the three months ended June 30, 2010, an increase of $1,204,894, or 65.5%, reflecting the increased expenses related to making investments in future new products and obtaining certifications for new product for automotive applications from automobile manufacturers.

Interest Expense, Net

Interest expense increased by $171,134, or 61.7%, from $277,264 during the three months ended June 30, 2010 to $448,398 for the three months ended June 30, 2011. The increase in interest expense resulted from obtaining additional borrowings of approximately $9,989,306 to support the rapid development of our business.

Changes in Fair Value of Warrants and Derivative Liabilities

Changes in fair value of warrants and derivative liabilities was a gain of $2,158,156 during the three months ended June, 2011, as compared to a loss of $712,768 for the three months ended June 30, 2010, primarily due to the change of fair value of warrants issued in connection with the private placement in December 2009 and common stock registered direct offering in October 2010.

Income Tax

Income tax was $4,488,056 during the three months ended June 30, 2011, as compared to $44,619 for the same period of 2010, an increase of $4,443,437, or approximately 9,958.6%. The increase was primarily due to the increased taxable income during the three months ended June 30, 2011 and the expiration of tax exemption of Harbin Xinda Macromolecule Material Research Institute (the “Research Institute”) which was deregistered in December 2010.

Net Income (Loss)

As a result of the above factors, we had a net income of $14,380,609 during the three months ended June 30, 2011, compared with a net loss of $2,956,372 during the three months ended June 30, 2010.

Comprehensive Income (Loss)

As a result of a currency translation adjustment, our comprehensive income was $15,890,701 during the quarter ended June 30, 2011, compared with comprehensive loss of $2,428,507 during the quarter ended June 30, 2010 because the exchange rate fluctuations from translation of our Chinese subsidiaries from Chinese RMB, their functional currency, to US dollar, our reporting currency.

Comparing Six Months Ended June 30, 2011 and 2010:

The following table sets forth information from our statements of operations for the six months ended June 30, 2011 and 2010, in dollars:

		Six Months Ended June 30,				$		%
		2011		2010		Change		Change

Revenues	$	164,332,409		112,047,102		52,285,307		46.7	%
Cost of Sales		(123,781,159	)	(85,345,782	)	(38,435,377	)	45.0	%
Gross Profit		40,551,250		26,701,320		13,849,930		51.9	%

Operating Expenses		(8,899,532	)	(20,261,681	)	(11,362,149)	)	(56.1	)%

Operating Income		31,651,718		6,439,639		25,212,079		391.55.9)	%

Interest Expenses, net		(794,859	)	(683,303	)	(111,556	)	16.3	%

Other Income, net		98,395		28,113		70,282		250.0	%

Changes in Fair Value of Warrants and Embedded Derivatives		2,699,613		4,408,886		(1,709,273	)	(38.8	)%

Income Tax Provision		(7,368,136	)	(67,351	)	(7,300,785	)	10,839.9	%

Net Income		26,286,731		10,125,984		16,160,747		159.6	%

Comprehensive Income	$	28,976,727		10,671,494		18,305,233		171.5	%

Net sales

During the six months ended June 30, 2011, we had net sales of $164,332,409, as compared with net sales of $112,047,102 during the same period in 2010, an increase of $52,285,307, or 46.7%, due to approximately a 34.7% increase in sales volume and an 8.9% increase in the average selling price of our products. The increase of sales volume was driven by the strong demand of modified plastics in the Chinese market and higher penetration of our business in our traditional 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 prices for plastic resins in general.

Revenues by product mix

The following table presents the breakdown of revenues in millions of US dollars by product mix:

	Revenues
(in millions, except	Six Months Ended June 30,
Percentage)	2011					2010
	Amount		%			Amount		%			Change in Amount		Change in %
Modified Polypropylene (PP)	$	99.05		60.27	%	$	66.18		59.07	%	$	32.87	$	49.67	%

Engineering Plastics		25.10		15.28	%		20.32		18.13	%		4.78		23.52	%

Modified Polyamide (PA)		10.98		6.68	%		7.66		6.83	%		3.32		43.34	%

Alloy Plastics		9.63		5.86	%		5.79		5.17	%		3.84		66.32	%

Environment Friendly Plastics		11.26		6.85	%		4.13		3.69	%		7.13		172.64	%

Modified Acrylonitrile Butadiene Styrene (ABS)		8.31		5.06	%		7.97		7.11	%		0.34		4.27	%

Total Revenues	$	164.33		100	%	$	112.05		100	%	$	52.28		46.66	%

The following table presents the product mix breakdown by thousands of metric tons (MT) of modified plastics sold to customers.

	Sales Volume
	Six Months Ended June 30,
	2011					2010
	MT		%			MT		%			Change in MT			Change in %
Modified Polypropylene (PP)		52,418		73.75	%		38,992		73.92	%		13,426			34.43	%

Engineering Plastics		5,315		7.48	%		4,108		7.79	%		1,207			29.38	%

Modified Polyamide (PA)		2,604		3.66	%		1,766		3.35	%		838			47.45	%

Alloy Plastics		3,141		4.42	%		2,246		4.25	%		895			39.85	%

Environment Friendly Plastics		4,661		6.56	%		2,051		3.89	%		2,610			127.25	%

Modified Acrylonitrile Butadiene Styrene (ABS)		2,932		4.13	%		3,586		6.80	%		(654	)		(18.24	)%

Total		71,071		100	%		52,749		100	%		18,322			34.73	%

Production Output by product mix

The following table summarizes the production output in tons (MT) by product mix in the first six (6) months of 2011 and 2010:

	Production Output
	Six Months Ended June 30,
	2011					2010
	MT		%			MT		%			Change in MT			Change in %
Modified Polypropylene (PP)		48,526		72.74	%		38,938		73.48	%		9,588			24.62	%

Engineering Plastics		5,095		7.65	%		4,223		7.97	%		872			20.65	%

Modified Polyamide (PA)		2,603		3.90	%		1,766		3.33	%		837			47.40	%

Alloy Plastics		3,591		5.38	%		2,244		4.23	%		1,347			60.03	%

Environment Friendly Plastics		4,211		6.31	%		2,274		4.30	%		1,937			85.18	%

Modified Acrylonitrile Butadiene Styrene (ABS)		2,684		4.02	%		3,543		6.69	%		(859	)		(24.24	)%

Total		66,710		100	%		52,988		100	%		13,722			25.90	%

Cost of Sales and Gross Margin

During the six months ended June 30, 2011, we had cost of sales of $123,781,159, as compared with cost of sales of $85,345,782 during the same period in 2010, an increase of approximately $38,435,377, or 45.0%, reflecting the increase in net sales. The gross profit rose to $40,551,250 for the six months ended June 30, 2011, or a 51.9% increase compared with $26,701,320 during the same period in 2010. Our gross margin increased to 24.68% during the six months ended June 30, 2011 from 23.83% during the six months ended June 30, 2010. The increase was mainly attributed to the increased sales of our high-end products as a percentage of total sales due to our efforts of 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 the per-vehicle-basis in China.

Selling Expenses

Our selling expenses increased by $226,539, or 106.3%, to $439,744 for the six months ended June 30, 2011, from $213,205 for the same period of 2010. As a percentage of sales, selling expenses increased from 0.2% for the six months ended June 30, 2010 to 0.3% for the same period of 2011. The increase of selling expenses was primarily due to an increase in advertising and promotion expenses related to marketing and promotional activities in our existing and new geographic markets.

General and Administrative Expenses

Our general and administrative expenses were $3,131,981 during the six months ended June 30, 2011, compared with $16,704,288 during the six months ended June 30, 2010, a decrease of $13,572,307 or approximately 81.3%. The decrease in general and administrative expenses was principally due to the non-cash stock compensation expense of options granted to Mr. Han of $13,355,832 for the six months ended June 30, 2010, as previously disclosed in Form 8-K on April 8, 2010.

Research and Development Expenses

Research and development expenses were $5,327,807 during the six months ended June 30, 2011 compared with $3,344,188 during the six months ended June 30, 2010, an increase of $1,983,619, or 59.3%, reflecting the increased expenses related to making investments in future new products and obtaining certifications for new products for automotive applications from automobile manufacturers. As of June 30, 2011, the number of ongoing research and development projects undertaken by our research center is 71, from which 51 projects we expect completion that could bring economic benefit in the near term and the remaining 20 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.

Interest Expense, Net

Interest expense increased by $111,556, or 16.3%, from $683,303 during the six months ended June 30, 2010 to $794,859 for the six months ended June 30, 2011. The increase in interest expense resulted from obtaining additional borrowings of approximately $9,989,306 to support the rapid development of our business.

Change in Fair Value of Warrants and Derivative Liabilities

Change in fair value of warrant and derivative liabilities was $2,699,613 during the six months ended June 30, 2011, as compared to $4,408,886 for the six months ended June 30, 2010, a decrease of $1,709,273 or approximately 38.8% due to the change of fair value of warrants and embedded conversion feature related to the private placement in December 2009 and common stock registered direct offering in October 2010.

Income Tax

Income tax was $7,368,136 during the six months ended June 30, 2011, as compared to $67,351 for the same period of 2010, an increase of $7,300,785, or approximately 10,839.9%. The increase was primarily due to the increased taxable income during the six months ended June 30, 2011 and the expiration of tax exemption enjoyed by Research Institute which was deregistered in December 2010.

Net Income

As a result of the factors described above, we generated net income of $26,286,731 during the six months ended June 30, 2011, as compared with net income of $10,125,984 during the six months ended June 30, 2010.

Comprehensive Income

As a result of a currency translation adjustment, our comprehensive income was $28,976,727 during the six months ended June 30, 2011, compared with $10,671,494 during the six months ended June 30, 2010, mainly because the exchange rate fluctuations from translation of our Chinese subsidiaries from Chinese RMB, their functional currency, to US dollar, our reporting currency.

Liquidity and Capital Resources

Summary consolidated balance sheet data:

	As of
	June 30,		December 31,				Changes in
	2011		2010		%		Variance			Note
in US$, except for percentages
Cash and cash equivalents		46,860,085		22,720,766		24,139,319		106	%
Accounts receivable, net of allowance for doubtful accounts		30,723,563		28,615,995		2,107,568		7	%	1	)
Inventories		19,133,623		25,257,083		-6,123,460		-24	%	2	)
Advances to suppliers		35,735,868		31,937,098		3,798,770		12	%	3	)
Property, plant and equipment, net		48,172,412		49,038,103		-865,691		-2	%
Deposit to acquire land use rights and construction in progress		12,827,230		-	NA				%	4	)
Deposit to acquire plant and equipment		4,643,046		-	NA					4	)
Total assets		199,762,934		159,399,101		40,363,833		25	%
Short term bank loans		30,633,889		21,204,700		9,429,189		44	%	5	)
Accounts payable		269,879		736,667		-466,788		-63	%
Tax payable		4,424,434		72,289		4,352,145		6,020	%	6	)
Other payables		2,406,534		2,314,966		91,568		4	%
Due to related parties		1,949,889		1,769,145		180,744		10	%

Total current liabilities		41,427,948		27,849,588		13,578,360		49	%
Common stock warrant purchase liabilities		3,020,058		5,719,130		-2,699,072		-47	%
Total equity		133,557,489		104,302,375		29,255,114		28	%

1)	In the six months ended June 30, 2011, the increase in accounts receivables of $2,107,568, mainly as a result of growth of revenues.

Days sales outstanding (“DSO”) is defined as average accounts receivable for the period divided by net sales for the period times 180. DSO increased by 10 days from 22 days for the six months ended June 30, 2010 to 32 days for the same period of 2011, due to slightly slower settlement by our customers. However, there was no uncollected accounts receivable over three months as of June 30, 2011.

2)	The decrease in inventory of $6,123,460 was mainly due to the reduction of finished goods at June 30, 2011 as a result of the increased sales in June 2011.

3)	We increased deposit to suppliers by $3,798,770 during the six month ended June 30, 2011 in anticipation of strong production demand in the third quarter.

4)	The total purchase price for the land use rights and construction project currently in process is RMB 435 million (approximately USD 67 million), of which RMB 352 million or approximately USD 54 million remains to be paid.

5)	As of June 30, 2011, our short term bank loans increased $9,429,189 compared to December 31, 2010 to support our working capital needs in order to meet the rapid development of our business.

6)	The increase in tax payable of $4,352,145 was primarily due to the increased taxable income during the six months ended June 30, 2011 and the expiration of a tax exemption enjoyed by Research Institute which was deregistered in December 2010.

As of June 30, 2011, we had $46,860,085 in cash and cash equivalents, of which $46,781,402 of cash and cash equivalents was held outside of the United States, compared to $22,720,766, of which $22,645,998 of cash and cash equivalents was held outside of the United States, as of December 31, 2010. There was an increase in cash and cash equivalents of $24,139,319. The net increase in cash and cash equivalents between June 30, 2011 and December 31, 2010 was mainly due to cash provided by operations, and more specifically, the decrease in inventory and accounts payables offset by the increase in tax payable, and deposits to acquire land use rights, construction in progress and plant and equipment.

Operations

For the six months ended June 30, 2011, cash provided by operations was $31,856,438, compared to cash provided by operations of $10,996,422 for the same period in 2010. The primary reason for the change was mainly due to (i) increase in net income from $10,125,984 for the six months ended June 30, 2010 to $26,286,731 for the six months ended June 31, 2011, (ii) decrease in inventory of $6,589,219 due to the reduction of inventory stocking; and (iii) increase in tax payable.

Investments

Cash used in investing activities was $17,591,428 for the six months ended June 30, 2011 as compared to cash provided by investing activities of $68,826 for the six months ended June 30, 2010 as we paid deposits of $17,270,261 to acquire land use rights, construction in progress and plant and equipment during the six months ended June 30, 2011.

Financing

For the six months ended June 30, 2011, net cash provided by financing activities was $9,125,854 as compared to net cash used in financing activities of $3,574,439 for the same period in 2010. Increase in cash provided by financing activities is sourced from the proceeds of the short term bank loans.

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.

The majority of the Company’s revenues and expenses were denominated primarily in Renminbi (“RMB”), the currency of the People’s Republic of China. 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.

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.

Critical Accounting Policies

This section should be read together with the Summary of Significant Accounting Policies included as Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2010 filed with the SEC.

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect our reporting of, among other things, assets and liabilities, contingent assets and liabilities and revenues and expenses. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experiences and other factors that we believe to be relevant under the circumstances. Since our financial reporting process inherently relies on the use of estimates and assumptions, our actual results could differ from our expectations. This is especially true with some accounting policies that require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our audited consolidated financial statements because they involve the greatest reliance on our management’s judgment.

Principles of consolidation

Allowance for Doubtful Receivables

Revenue recognition

The Company’s revenue recognition policies are in compliance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC 605”) “Revenue Recognition”. In accordance with FASB ASC 605, revenues are recognized when the four following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the delivery is completed, (iii) the fees are fixed or determinable, and (iv) collectability is reasonably assured.

Inventories

Stock Based Compensation

The Company accounts for stock-based compensation arrangements using the fair value method in accordance with FASB ASC 718 “Compensation-Stock Compensation”. FASB ASC 718 requires that the fair value of share awards issued, modified, repurchased or cancelled after implementation, under share-based payment arrangements, is measured as of the date the award is issued, modified, repurchased or cancelled. The resulting cost is then recognized in the statement of income and comprehensive income over the service period.

The Company estimates fair value of restricted stock based on the number of shares granted and the quoted price of the Company’s common stock on the date of grant.

Accounting for the Series C preferred stock

Accounting for embedded conversion feature

The Company applied FASB ASC 815 to account for the embedded conversion features related to its Series C preferred stock. The embedded conversion feature is a derivative that must be bifurcated from the host instrument and accounted for at fair value with changes in fair value recorded in earnings.

Accounting for warrants

The Company analyzed the warrants issued in the December 2009 financing in accordance with FASB ASC 815, to determine whether the warrants meet the definition of a derivative and, if so, whether the warrants meet the scope exception of FASB ASC 815, which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity shall not be considered to be derivative instruments for purposes of FASB ASC 815.

The Company also considered the provisions of FASB ASC 815-40, which applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by FASB ASC 815, and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.

As a result of its interpretation of FASB ASC 815-40, the Company concluded that the warrants issued in the December 2009 financing should be treated as a derivative liability because the warrants are entitled to a price adjustment provision to allow the exercise price to be reduced in the event the Company issues or sells any additional shares of common stock at a price per share less than the then-applicable exercise price or without consideration, which is typically referred to as a “Down-round protection” or “anti-dilution” provision. According to FASB ASC 815-40, the “Down-round protection” provision is not considered to be an input to the fair value of a fixed-for-fixed option on equity shares which leads the warrants to fail to be qualified as indexed to the Company’s own stock and then to fail to meet the scope exceptions of FASB ASC 815.

As a result of its interpretation of FASB ASC 815-40, the Company concluded that the warrants issued in the October 2010 registered direct offering should be treated as a derivative liability because the warrants are entitled to a net cash settlement provision if the Company fails to cause the transfer agent to timely transmit to the holder a certificate or certificates representing the shares of common stock upon exercise pursuant to the clause “Compensation for Buy-In on Failure to Timely Deliver Certificates Upon Exercise”. Pursuant to FASB ASC 815, derivatives are measured at fair value and re-measured at fair value with changes in fair value recorded in earnings at each reporting period.

Therefore, the Company accounted for the warrants as derivative liabilities under FASB ASC 815. Pursuant to FASB ASC 815, derivatives are measured at fair value and re-measured at fair value with changes in fair value recorded in earnings at the end of each reporting period.

Recent Accounting Pronouncements

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

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 because of weaknesses in our internal control over financial reporting as disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

The material weaknesses could result in a misstatement of the aforementioned accounts or disclosures that might result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. However, giving full consideration to these material weaknesses, we performed adequate analyses and procedures, including among other things, and in addition to the remediation initiatives the Company has implemented as identified in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, transaction reviews and account reconciliations in order to provide assurance that our unaudited consolidated financial statements included in this Quarterly Report were prepared in accordance with generally accepted accounting principles (“GAAP”) and present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP. As a result of these procedures, we concluded that the unaudited consolidated financial statements included in this Quarterly Report present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the fiscal quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

None.

Item 1A. Risk Factors.

As of the date of this filing, there have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K filed on March 31, 2011 except the following. We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could materially affect our operations. The risks, uncertainties and other factors set forth in our Annual Report on Form 10-K may cause our actual results, performances and achievements to be materially different from those expressed or implied by our forward-looking statements. If any of these risks or events occurs, our business, financial condition or results of operations may be adversely affected.

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 PRC State Administration of Foreign Exchange, or SAFE, issued a public notice in 2005 known as Circular 75 that requires PRC residents, including both legal persons and natural persons, to register with an appropriate local SAFE branch before establishing or controlling any company outside of China, referred to as an offshore special purpose company, for the purpose of acquiring any assets of or equity interest in PRC companies and raising funds from overseas. When a PRC resident contributes the assets or equity interests it holds in a PRC company into the offshore special purpose company, or engages in overseas financing after contributing such assets or equity interests into the offshore special purpose company, such PRC resident must modify its SAFE registration in light of its interest in the offshore special purpose company and any change thereof. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. If these shareholders fail to comply, the PRC subsidiaries of the offshore special purpose company may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to their offshore parent company and the offshore parent company may be restricted in its ability to contribute additional capital into its PRC subsidiaries. Moreover, failure to comply with the above SAFE registration requirements could result in liabilities under PRC laws for evasion of foreign exchange restrictions.

We are committed to complying with the Circular 75 requirements and to ensuring that our shareholders who are PRC citizens or residents comply with them. We believe that all of our current PRC citizen or resident shareholders and beneficial owners have completed their required registrations with SAFE. However, we may not at all times be fully aware or informed of the identities of all our beneficial owners who are PRC citizens or residents, and we may not always be able to compel our beneficial owners to comply with the Circular 75 requirements. As a result, we cannot assure you that all of our shareholders or beneficial owners who are PRC citizens or residents will at all times comply with, or in the future make or obtain any applicable registrations or approvals required by, Circular 75 or other related regulations. Failure by any such shareholders or beneficial owners to comply with Circular 75 could subject us to fines or 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, which could adversely affect our business and prospects.

In addition, the PRC National Development and Reform Commission promulgated a rule in 2004 requiring its approval for overseas investment projects made by PRC entities. However, there exist extensive uncertainties as to the interpretation of this rule with respect to its application to a PRC individual’s overseas investment and, in practice, we are not aware of any precedents that a PRC individual’s overseas investment has been either approved by the National Development and Reform Commission or challenged by the National Development and Reform Commission based on the absence of its approval. Our current beneficial owners who are PRC individuals did not apply for the approval of the National Development and Reform Commission for their investment in us. We cannot predict how and to what extent this will affect our business operations or future strategy.

We may be subject to fines and legal sanctions imposed by SAFE or other Chinese government authorities if we or our Chinese employees or directors fail to comply with recent Chinese regulations relating to employee share options or shares granted by offshore special purpose companies or offshore listed companies to Chinese citizens.

On December 25, 2006, the People’s Bank of China issued the Administration Measures on Individual Foreign Exchange Control, and the corresponding Implementation Rules were issued by SAFE on January 5, 2007. Both of these regulations became effective on February 1, 2007. According to these regulations, all foreign exchange matters relating to employee stock holding plans, share option plans or similar plans with PRC citizens’ participation 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 are granted share options or shares by an offshore listed company are required, through a Chinese agent or Chinese subsidiary of the offshore listed company, to register with SAFE and complete certain other procedures. We are an offshore listed company and as a result we and our Chinese employees who have been granted share options or shares under our incentive plan are subject to the Stock Option Rule. However, local SAFE at Heilongjiang Province orally confirmed to us that we don’t need to get any prior approval or registration from it, and only verification shall be handled when (i) a foreign exchange account shall be established by us for the purpose of option sale or exercise, and (ii) our employees intend to sell their shares or to purchase foreign currencies to exercise their options. Therefore, it remains unclear whether we shall get SAFE registration in terms of our incentive plan pursuant to the Stock Option Rule.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. (Removed and Reserved).

Item 5. Other Information.

None.

Item 6. Exhibits.

(a) Exhibits

Exhibit No.	Description
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.
32.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

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

		China XD Plastics Company Limited

Date: August 15, 2011		/s/ Jie Han
		Jie Han Chief Executive Officer (Principal Executive Officer)


Date: August 15, 2011		/s/ Taylor Zhang
		Taylor Zhang Chief Financial Officer

Attached files

China XD Plastics Co Ltd Reports

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