Form 10-Q Home System Group

Quarterly report pursuant to section 13 and 15(d)

What is Form 10-Q?
  • Accession No.: 0001214659-08-001859 Act: 34 File No.: 000-49770 Film No.: 081017269
  • CIK: 0001172319
  • Submitted: 2008-08-14
  • Period of Report: 2008-06-30

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2008 HTML

f8118010q.htm



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

FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended June 30, 2008
   
 
OR
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from ________________ to ________________

Commission file number:  000-49770

Home System Group
(Exact name of registrant as specified in its charter)

Nevada
 
43-1954776
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
Oceanic Industry Park, Sha Gang Highway, Gang Kou Town
Zhongshan City, Guangdong
People's Republic of China
 
528447
(Address of principal executive offices)
 
(Zip Code)

(86 755) 8357-0142 
 (Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
   
Yes o             No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” 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
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class
 
Outstanding at August 13, 2008
Common Stock, $0.001 par value per share
 
62,477,949 shares
 




HOME SYSTEM GROUP
FORM 10-Q

TABLE OF CONTENTS
 


 
Except as otherwise required by the context, all references in this report to "we", "us”, "our",  or "Company" refer to the consolidated operations of Home System Group, a Nevada corporation, and its wholly owned subsidiaries.

 

Item 1. Financial Statements.






 

HOME SYSTEM GROUP AND SUBSIDIARIES

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED

JUNE 30, 2008 AND 2007

(UNAUDITED)







3

 
C O N T E N T S







 
HOME SYSTEM GROUP AND SUBSIDIARIES
CONDSENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2008 AND DECEMBER 31, 2007
(Expressed in US dollars except for number of shares)

   
June 30,
   
December 31,
 
   
2008
   
2007
 
   
(unaudited)
   
(audited)
 
ASSETS
           
             
CURRENT ASSETS
           
Cash and cash equivalents
  $ 215,094     $ 821,074  
Restricted cash
    957,025       -  
Accounts receivable – trade
    8,577,315       10,706,256  
Other receivables
    1,194,400       1,056,946  
Inventories
    2,851,440       5,267,728  
Trade deposits
    498,934       434,734  
Income tax refundable
    80,399       75,550  
TOTAL CURRENT ASSETS
    14,374,607       18,362,288  
                 
Acquisition deposits
    8,024,500       7,540,500  
Property, plant and equipment – net
    6,174,061       5,986,847  
                 
TOTAL ASSETS
  $ 28,573,168     $ 31,889,635  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES
               
Bills payable
  $ 2,392,562     $ -  
Accounts payable – trade
    10,240,203       15,497,372  
Accrued expenses and other payables
    2,112,640       1,411,351  
Taxes payable
    374,411       802,054  
Due to a stockholder – current portion
    850,664       304,366  
TOTAL CURRENT LIABILITIES
    15,970,480       18,015,143  
                 
NON-CURRENT LIABILITIES
               
Due to a stockholder – non-current portion
    600,000       600,000  
Notes payable
    6,575,000       6,575,000  
                 
TOTAL LIABILITIES
  $ 23,145,480     $ 25,190,143  
                 
STOCKHOLDERS' EQUITY
               
                 
COMMON STOCK - $0.001 par value; 200,000,000 shares
               
authorized, 62,477,949 shares issued and outstanding
  $ 62,478     $ 62,478  
                 
ADDITIONAL PAID-IN CAPITAL
    6,581,717       6,615,726  
                 
NOTE RECEIVABLE ON STOCK ISSUANCE
    (900,000 )     (900,000 )
                 
STATUTORY RESERVES
    29,616       29,616  
                 
(ACCUMULATED DEFICIT) RETAINED EARNINGS
    (1,912,684 )     150,161  
                 
CUMULATIVE TRANSLATION ADJUSTMENT
    1,566,561       741,511  
                 
TOTAL STOCKHOLDERS' EQUITY
  $ 5,427,688     $ 6,699,492  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 28,573,168     $ 31,889,635  
 
See accompanying notes to condensed consolidated financial statements
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS /INCOME
AND COMPREHENSIVE (LOSS) INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(Expressed in US dollars except for number of shares)
(UNAUDITED)

   
Three Months Ended June 30
   
Six Months Ended June 30,
 
   
2008
   
2007
   
2008
   
2007
 
                         
NET SALES
  $ 8,575,118     $ 11,226,912     $ 16,253,607     $ 22,943,679  
Cost of sales
    8,124,279       9,783,876       16,772,303       19,942,630  
GROSS PROFIT (LOSS)
    450,839       1,443,036       (518,696 )     3,001,049  
                                 
OPERATING EXPENSES
                               
Provision for stock option costs written back
    -       -       (34,009 )     -  
General selling and administrative expenses
    780,236       784,488       1,617,324       1,339,709  
      780,236       784,488       1,583,315       1,339,709  
                                 
(LOSS) INCOME FROM OPERATIONS
    (329,397 )     658,548       (2,102,011 )     1,661,340  
                                 
OTHER INCOME (EXPENSE)
                               
Other income
    68,260       -       67,001       -  
Interest expenses
    (16,993 )     (577 )     (27,835 )     (577 )
Interest income
    -       7,832       -       8,013  
      51,267       7,255       39,166       7,436  
                                 
(LOSS) INCOME BEFORE INCOME TAXES
    (278,130 )     665,803       (2,062,845 )     1,668,776  
                                 
INCOME TAXES
    -       (1,391 )     -       (72,483 )
                                 
NET (LOSS) INCOME
    (278,130 )     664,412       (2,062,845 )     1,596,293  
                                 
OTHER COMPREHENSIVE INCOME
                               
Foreign currency translation adjustment
    280,264       68,416       825,050       108,471  
                                 
COMPREHENSIVE (LOSS) INCOME
  $ 2,134     $ 732,828     $ (1,237,795 )   $ 1,704,764  
                                 
(LOSS) EARNINGS PER SHARE
                               
-BASIC
  $ 0.00     $ 0.01     $ (0.02 )   $ 0.03  
-DILUTED
  $ 0.00     $ 0.01     $ (0.02 )   $ 0.03  
                                 
WEIGHTED AVERAGE NUMBER OF SHARES
                               
-BASIC
    62,477,949       62,447,949       62,477,949       58,997,472  
-DILUTED
    62,477,949       62,447,949       62,477,949       58,997,472  
 
See accompanying notes to condensed consolidated financial statements
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2007 AND SIX MONTHS ENDED JUNE 30, 2008
(Expressed in US dollars except for number of shares)

                     
Note
         
Retained
             
   
Number of
         
Additional
   
Receivable
         
Earnings /
   
Cumulative
       
   
Shares of
   
Common
   
Paid-in
   
On Stock
   
Statutory
   
(Accumulated
   
Translation
       
   
Common Stock
   
Stock
   
Capital
   
Issuance
   
Reserves
   
Deficit)
   
Adjustment
   
Total
 
BALANCES AT DECEMBER 31, 2006 (audited)
    42,500,000     $ 42,500     $ 3,709,025     $ -     $ -     $ 118,249     $ 99,363     $ 3,969,137  
                                                                 
Effects of reverse merger
    19,797,949       19,798       2,032,355       -       -       -       -       2,052,153  
                                                                 
Notes receivable on acquisition merger
    -       -       -       (900,000 )     -       -       -       (900,000 )
                                                                 
Issuance of common stock for prepaid expenses
    150,000       150       622,350       -       -       -       -       622,500  
                                                                 
Issuance of common stock for
employees
    30,000       30       149,970       -       -       -       -       150,000  
                                                                 
Stock options costs
    -       -       102,026       -       -       -       -       102,026  
                                                                 
Appropriation to reserves
    -       -       -       -       29,616       (29,616 )     -       -  
                                                                 
Cumulative translation adjustment
    -       -       -       -       -       -       642,148       642,148  
                                                                 
Net income for the year
    -       -       -       -    
- 
      61,528       -       61,528  
                                                                 
BALANCES AT DECEMBER 31, 2007- (audited)
    62,477,949     $ 62,478     $ 6,615,726     $ (900,000 )   $ 29,616     $ 150,161     $ 741,511     $ 6,699,492  
                                                                 
Translation adjustment
    -       -       -       -       -       -       825,050       825,050  
                                                                 
Provision for stock option costs written back
    -       -       (34,009 )     -       -       -       -       (34,009 )
                                                                 
Net (loss) for the period
    -       -       -       -       -       (2,062,845 )     -       (2,062,845 )
                                                                 
BALANCE AT JUNE 30, 2008 -
(unaudited)
    62,477,949     $ 62,478     $ 6,581,717     $ (900,000 )   $ 29,616     $ (1,912,684 )   $ 1,566,561     $ 5,427,688  
 
See accompanying notes to condensed consolidated financial statements
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(Expressed in US dollars)
 (UNAUDITED)
   
Six Months Ended June 30,
 
   
2008
   
2007
 
             
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net (loss) income
  $ (2,062,845 )   $ 1,596,293  
Adjustments to reconcile net (loss) income
               
to net cash (used in) provided by operating activities
               
Depreciation
    249,312       133,084  
Provision for stock option costs written back
    (34,009 )     -  
Change in assets and liabilities:
               
(Increase) decrease in assets
               
Accounts receivable – trade
    2,147,068       4,904,027  
Other receivables
    (63,223 )     -  
Prepaid expense
    -       (530,941 )
Inventories
    2,706,643       1,705,178  
Trade deposits
    434,734       1,831,763  
Increase (decrease) in liabilities
               
Bills payable
    2,292,530       -  
Accounts payable – trade
    (5,945,315 )     (109,094 )
Accrued expenses and other payables
    549,805       -  
Employee advances
    -       4,391  
Taxes payable
    (450,912 )     456,813  
Net cash (used in) provided by  operating activities
    (176,212 )     9,991,514  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Capital expenditures
    (58,466 )     (1,869,605 )
Cash acquired in merger
    -       55,980  
Net cash used in investing activities
    (58,466 )     (1,813,625 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Repayment of bank loans
    -       (1,745,000 )
Increase in restricted cash
    (937,512 )     -  
Net decrease in due to related party
    (6,621 )     667,680  
Net decrease in due from related party
    -       (2,519,975 )
Increase in due to stockholder
    546,300       155,980  
Dividend distribution for acquisition
    -       (3,000,000 )
Net cash used in financing activities
    (397,833 )     (6,441,315 )
                 
EXCHANGE RATE EFFECT ON CASH
    26,531       108,475  
                 
NET (DECREASE) INCREASE  IN CASH
    (605,980 )     1,845,049  
                 
CASH - BEGINNING OF PERIOD
    821,074       6,012  
                 
CASH - END OF PERIOD
  $ 215,094     $ 1,851,061  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
               
Cash paid during the period for:
               
Interest
  $ 27,469     $ 82,112  
Income tax paid
  $ -     $ 51,495  
                 
Supplemental disclosure of non cash financing
               
Issuance of common stock for prepaid expenses
  $ -     $ 622,500  
Proceeds from subscription receivable paid directly for acquisition deposit
  $ -     $ 6,575,000  

See accompanying notes to condensed consolidated financial statements
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 – BASIS OF PREPARATION

The accompanying unaudited consolidated financial statements have been prepared by Home System Group (“HSG”) and Subsidiaries (collectively, the “Company”).  These statements include all adjustments (consisting only of their normal recurring adjustments) which management believes necessary for a fair presentation of the statements and have been prepared on a consistent basis using the accounting policies described in the Form 10-KSB for the year ended December 31, 2007 (“2007 Form 10-KSB”).  Certain financial information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although the Company firmly believes that the accompanying disclosures are adequate to make the information presented not misleading.  The Notes to Financial Statements included in the 2007 Form 10-KSB should be read in conjunction with the accompanying interim financial statements.  The interim operating results for the six months ended June 30, 2008 may not be indicative of operating results expected for the full year.

The financial statements have been prepared on the basis that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. The Company had net loss of $2,062,845 for the six months ended June 30, 2008 and at that date, the Company also had an accumulated deficit of $1,912,684 and current liabilities exceeded current assets by $1,595,873.

Operations to date have been primarily financed by stockholder advances and private equity investments. As a result, the Company's future operations are dependent upon the identification and successful completion of permanent equity investment and/or financing, the continued support of shareholders and ultimately, the achievement of profitable operations. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts nor to amounts and classification of liabilities that may be necessary should it be unable to continue as a going concern.

NOTE 2 – ORGANISATION AND NATURE OF BUSINESS

Home System Group, Inc. (“HSGI”) was incorporated with limited liability in The British Virgin Islands on February 28, 2003.  HSGI, with a minimum capitalization of $2 and, was inactive until June 30, 2006 when HSGI acquired all the issued and outstanding stock of Oceanic International (HK) Limited (“Oceanic”).  Oceanic is an operating company organized under the laws of Hong Kong on June 23, 2004 for the purpose of trading gas grills, home electronic appliances and bin racks. Since the ownership of HSGI and Oceanic were the same, the merger was accounted for as a transaction between entities under common control, whereby HSGI recognized the assets and liabilities transferred at their carrying amounts.

On August 4, 2006, Supreme Realty Investments, Inc. (“Supreme”), a public shell company, acquired HSGI. Under the terms of the merger agreement, the stockholders of HSGI received 8,000,000 (post reverse stock split) shares of common stock of Supreme for 100% of HSGI’s outstanding common stock.  Following the merger, the Company changed its name to Home System Group (“HSG”).  Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction in substance, rather than a business combination.  That is, the share exchange is equivalent to the issuance of stock by HSGI for the net monetary assets of Supreme, accompanied by a recapitalization, and is accounted for as a change in capital structure.  Accordingly, the accounting for the share exchange is identical to that resulting from a reverse acquisition, except no goodwill will be recorded.  Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, Supreme, are those of the legal acquiree which are considered to be the accounting acquirer, HSGI.  Shares and per share amounts stated have been adjusted to reflect the merger.

Holy (HK) Limited was incorporated in Hong Kong on September 26, 2006 for the purpose of being a holding company.  Oceanic Well Profit, Inc. (“Well Profit”), a wholly-owned subsidiary of Holy, was incorporated in the Peoples Republic of China (“PRC”) on April 5, 2006 for the purpose of manufacturing gas grills, home electronic appliances and bin racks.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 2 – ORGANISATION AND NATURE OF BUSINESS (Continued)

Holy, with a minimum capitalization of $1,285, was inactive until October 26, 2006 when Holy acquired all the issued and outstanding stock of Well Profit for approximately $3,750,000, the net book value of Well Profit. Since the stockholders of Holy and Well Profit were related, and the control of the merged entity remained with the management of Well Profit and, the merger was accounted for as a transaction between entities under common control, whereby Holy recognized the assets and liabilities transferred at their carrying amounts.  The consolidated financial statements combine the historical financial statements of Holy and Well Profit as if the merger occurred at the beginning of the periods presented.

On January 31, 2007, Home System Group (“HSG”) acquired Holy (HK) Limited and its wholly-owned subsidiary Well Profit (collectively, “Holy”).  Under the terms of the merger agreement, the stockholders of Holy received $3,000,000 and 42,500,000 shares of voting common stock of HSG in exchange for 100% of Holy’s outstanding common stock. For accounting purposes, the acquisition has been treated as an acquisition of HSG by Holy and as a recapitalization of Holy. The historical financial statements prior to January 31, 2007 are those of Holy. Share and per share amounts have been retroactively adjusted to reflect the acquisition.
 
On June 26, 2007, the Company entered into a share exchange agreement with Zhongshan Weihe Electrical Appliances Co. Ltd. ("Weihe") and Weihe's shareholders, pursuant to which the Company agreed to acquire 100% equity interests in Weihe for an aggregate consideration of approximately $45,000,000, consisting of 4,500,000 newly issued shares of HSG's common stock, (stock price valued at $4.66 per share – average share price 5 trading days in which there were transactions prior to the acquisition) and $27,000,000 in cash payable as follows: $10,800,000 due on the first anniversary of the closing of the transaction, and $16,200,000 due on the second anniversary of closing of the transaction.
 
On April 20, 2007, the Company entered into a Share Exchange Agreement (the "Agreement") pursuant to which Well Profit acquired 100% of Zhongshan Juxian Gas Oven Co. Ltd. ("Juxian") in a stock and cash transaction valued at approximately $14,000,000. Under the Agreement, in exchange of surrendering their shares in Juxian, the stockholders of Juxian would receive both stock consideration, (stock price at  $4.59 per share – average share price 5 trading days in which there were transactions prior to the acquisition) and cash consideration from HSG. The stock consideration would consist of 1,000,000 newly issued shares of the HSG common stock. The cash consideration would consist of $10,000,000 in cash payable as follows: $5,000,000 due on the first anniversary of the closing of the transaction, which was July 2, 2007 and $5,000,000 due on the second anniversary of closing of the transaction.
 
However, as the delivery of the Company's stock, which is traded on the OTCBB, has not been recognized as share exchange consideration by the relevant PRC government authority for the purposes of approval of the ownership transfer of Weihe and Juxian, on February 7, 2008, the Company cancelled the acquisition of Weihe and Juxian and both share exchange agreements.
 
 
NOTE 3 – REVERSE ACQUISITION
 
On January 31, 2007, HSG completed the acquisition of Holy (H.K.) Limited ("Holy") and Oceanic Well Profit Inc. ("Oceanic") (the "Transaction") pursuant to a share exchange agreement ("Share Exchange Agreement") between HSG, Holy, Oceanic and the then sole shareholder of Holy ("Holy Shareholder"). Pursuant to the Share Exchange Agreement, HSG issued 42,500,000 shares of its common stock, representing 68.2% of HSG's issued and outstanding common stock immediately following the Transaction, and paid $3,000,000 cash to Holy Shareholder in exchange of 100% equity interest in Holy. Holy was incorporated in Hong Kong as an investment holding company for the primary purpose of holding 100% ownership interest in Oceanic. Oceanic was incorporated in the PRC and engages in manufacturing of gas grills, home electronic appliances, skateboards and bin racks.
 
Before the Transaction, HSG conducted all of its substantive business through a wholly-owned subsidiary, Oceanic International (HK) Limited ("OCIL"). OCIL was a distributor of home appliance products without any manufacturing base or facilities.  In conjunction with the Transaction, management of the Company has determined to abandon and discontinue the operations of OCIL and has treated HSG as a shell corporation.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
As Holy Shareholder has become the majority shareholder of the consolidated entity comprising HSG and Holy, the Transaction has been accounted for as a reverse acquisition using the purchase method of accounting, where HSG (the legal acquirer) is deemed to be the accounting acquiree and Holy (the legal acquiree) to be the accounting acquirer. However, the Transaction is also considered to be a capital transaction in substance as Holy (a private operating company) has been merged into HSG (a public shell corporation with nominal non-monetary net assets) with the shareholders of HSG, the former public shell continuing only as passive investors.  Hence, the cost of the transaction has been measured at the carrying value of the net assets of HSG with no goodwill or other intangible being recorded in accordance with the accounting interpretation and guidance issued by the SEC staff.
 
HSG is deemed to be a continuation of the business of Holy and the financial statements prior to January 31, 2007 are those of Holy. The results of HSG have been consolidated from the date of the Transaction.
 
The allocation of the cost of the Transaction is as follows:
 
Cash
  $ 55,980  
Accounts receivable
    3,656,646  
Due from a related party
    2,344,415  
Trade deposits
    2,543,165  
Equipment
    998  
Bank loans
    (1,745,000 )
Accounts payable
    (2,696,515 )
Accrued expenses
    (2,179 )
Due to directors
    (1,280 )
Due to related party
    (4,077 )
      4,152,153  
Stock subscription receivable
    900,000  
Net assets of HSG deemed to be acquired by Holy
    5,052,153  
         
Satisfied by:
       
Shares of HSG
    2,052,153  
Cash
    3,000,000  
      5,052,153  
 
The following unaudited pro forma information assumes the Transaction occurred on the beginning of the year or the period presented respectively. These unaudited pro forma results have been prepared for informational purposes only and do not purport to represent what the results of operations would have been had the Transaction occurred as of the date indicated, nor of future results of operations. The unaudited pro forma results for the year ended December 31, 2007 and the period from April 5, 2006 to December 31, 2006 are as follows:
 
   
Year ended December 31, 2007
   
Period from April 5 to December 31, 2006
 
             
Net sales
  $ 43,436,764     $ 30,329,606  
Net income
  $ 449,540     $ 1,472,052  
Earnings per share (basic and diluted)
  $ 0.007     $ 0.024  
                 
Weighted average number of shares (basic and diluted)
    62,430,689       62,297,949  
 
NOTE 4 – BASIS OF CONSOLIDATION

The accompanying unaudited financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America.

The consolidated financial statements include the accounts of the Company and its subsidiaries.  All significant inter-company accounts and transactions have been eliminated in consolidation.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 5 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basic and Diluted Earnings (Loss) Per Share

The Company reports basic earnings per share in accordance with SFAS No. 128, “Earnings Per Share”.  Basic earnings per share is computed using the weighted average number of shares outstanding during the periods presented.  The weighted average number of shares of the Company represents the common stock outstanding during the reporting periods.

Diluted earning per share is based on the assumption that all dilutive options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options are assumed to be exercised at the time of issuance, and as if funds obtained thereby were used to purchase common stock at the average market price during the year.

The Company reports its diluted earnings per share exclude all options because they are anti-dilutive.

Comprehensive Income

The Company follows the Statement of Financial Accounting Standard (“SFAF”) No. 130, “Reporting Comprehensive Income.” Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income.

Recently Issued Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which is effective for fiscal years beginning after November 15, 2007 with earlier adoption encouraged. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157 which delayed the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. The Company has not yet determined the impact the implementation of SFAS 157 will have on the Company’s non-financial assets and liabilities which are not recognized or disclosed on a recurring basis.  However, the Company does not anticipate that the full adoption of SFAS 157 will significantly impact their consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 (“SFAS 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company adopted SFAS 159 on January 1, 2008, but the implementation of SFAS 159 did not have a significant impact on the Company's financial position or results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement is effective for the Company beginning January 1, 2009. The Company is currently evaluating the potential impact of the adoption of SFAS 141R on its consolidated financial position, results of operations or cash flows.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51 (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This statement is effective for the Company beginning January 1, 2009. The Company is currently evaluating the potential impact of the adoption of SFAS 160 on its consolidated financial position, results of operations and cash flows.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (“FAS 162"). This Standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. FAS 162 directs the hierarchy to the entity, rather than the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with generally accepted accounting principles. The Standard is effective 60 days following SEC approval of the Public Company Accounting Oversight Board amendments to remove the hierarchy of generally accepted accounting principles from the auditing standards. FAS 162 is not expected to have an impact on the financial statements.

Recently Issued Accounting Pronouncements

In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. This Staff Position is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. Application of this FSP is not expected to have a significant impact on the financial statements.

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. This FSP provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The Company does not currently have any share-based awards that would qualify as participating securities. Therefore, application of this FSP is not expected to have an effect on the Company's financial reporting.

In May 2008, the FASB issued FASB Staff Position (FSP) APB 14-1, Accounting for Convertible Debt That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) ("FSP 14-1"). FSP 14-1 will be effective for financial statements issued for fiscal years beginning after December 15, 2008. The FSP includes guidance that convertible debt instruments that may be settled in cash upon conversion should be separated between the liability and equity components, with each component being accounted for in a manner that will reflect the entity's nonconvertible debt borrowing rate when interest costs are recognized in subsequent periods. FSP 14-1 is not currently applicable to the Company since the Company does not have convertible debt.

Long-Lived Assets

Long-lived assets, other than goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or any other significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable.

For long-lived assets used in operations, impairment losses are only recorded if the asset’s carrying amount is not recoverable through its undiscounted, probability-weighted cash flows. We measure the impairment loss based on the difference between the carrying amount and estimated fair value.

Long-lived assets are considered held for sale when certain criteria are met, including: management’s commitment to a plan to sell the asset, the asset is available for sale in its immediate condition, and the sale is probable within one year of the reporting date. Assets held for sale are reported at the lower of cost or fair value less costs to sell.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
Control By Principal Stockholders

The directors, executive officers and their affiliates or related parties, if they voted their shares uniformly, could have the ability to control the approval of most corporate actions, including increasing the authorized capital stock of the Company and the dissolution, merger or sale of the Company's assets.

Use Of Estimates

The preparation of the financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Significant Estimates

Several areas require management's estimates relating to uncertainties for which it is reasonably possible that there will be a material change in the near term. The more significant areas requiring the use of management estimates related to valuation of intangible assets acquired in business acquisitions, accrued liabilities and the useful lives for amortization and depreciation.

NOTE 6 –RELATED PARTIES TRANSACTIONS

During the six month periods ended June 30, 2008, the Company had the transactions with certain former related companies in the normal course of business. Those related companies ceased to be related to the Company in August 2007 when two of the Company’s shareholders sold their interests. The value of transactions with those related companies up to June 2007 when they related to the Company are as follows:

   
For the six months ended June 30, 2008
   
For the six months ended June 30, 2007
 
             
             
Sales to the related companies
  $ -     $ 115,170,541  
Percentage of total net sales
    - %     50 %
Purchases from the related companies
  $ -     $ 6,802,155  
Percentage of total purchases
    - %     34 %
Rental expenses paid to related companies
  $ -     $ 230,483  
Building management fee paid to related companies
  $ -     $ 4,954  

NOTE 7 – PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment consist of the following:

   
June 30,
2008
   
December 31,
2007
 
At cost:
           
Plant and machinery
  $ 6,290,190     $ 6,278,535  
Furniture, fixtures and equipment
    563,245       87,831  
                 
Total
    6,853,435       6,366,366  
                 
Less: accumulated depreciation
    679,374       379,519  
Net book value
  $ 6,174,061     $ 5,986,847  

During the three months ended June 30, 2008, depreciation expenses amounted to $102,249, among which $98,166 and $4,063 were recorded as cost of sales and administrative expense respectively.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
During the three months ended June 30, 2007, depreciation expenses amounted to $68,665, among which $55,755 and $12,910 were recorded as cost of sales and administrative expense respectively.

During the six months ended June 30, 2008, depreciation expenses amounted to $249,312, among which $241,219 and $8,093 were recorded as cost of sales and administrative expense respectively.

During the six months ended June 30, 2007, depreciation expenses amounted to $133,084, among which $107,265 and $25,819 were recorded as cost of sales and administrative expense respectively.

NOTE 8 – ACQUISITION DEPOSIT

The acquisition deposit of $8,024,500 and $7,540,500 as of June 30, 2008 and December 31, 2007 respectively, represented the partial payment of the cash portion of the consideration for the acquisition of Weihe, as further discussed in Note 2. However, the delivery of the Company's stock, which is traded on the OTCBB, has not been recognized as a share exchange consideration by the relevant PRC government authority for the purposes of approval of the ownership transfer of Weihe. On February 7, 2008, the share exchange agreement for the acquisition of Weihe was cancelled. The Company has been in negotiation with the shareholders of Weihe for new terms of the acquisition of Weihe and intends to enter into a new agreement to acquire Weihe. The deposit paid under the original agreement will be applied to the new agreement.
 
NOTE 9 – RESTRICTED CASH AND BILLS PAYABLE
 
   
June 30,
2008
   
December 31,
2007
 
             
Bank deposits held as collateral for bills payable
  $ 957,025     $ -  
 
Bills payable
  $ 2,392,562     $ -  
                 

The Company is requested by certain of its suppliers to settle amounts owed to such suppliers by the issuance of bills through banks for which the banks undertake to guarantee the Company’s settlement of these amounts at maturity. These bills are interest−free with maturity dates of six months from the date of issuance. As security for the banks’ undertakings, the Company is required to pay the banks’ charges as well as deposit with such banks amounts equal to 40% of the bills’ amount at the time of such issuance.

NOTE 10 – INVENTORIES

Inventories consist of the following:
 
   
June 30,
2008
   
December 31,
2007
 
Raw materials
  $ 797,784     $ 1,695,194  
Work in process
    1,853,214       2,167,281  
Consumable
    98,027       70,950  
Finished goods
    102,415       1,334,303  
 
Total
  $ 2,851,440     $ 5,267,728  

NOTE 11 – SEGMENT REPORTING

Statement of Financial Accounting Standards No 131 ("SFAS 131"), "Disclosure About Segments of an Enterprise and Related Information", requires use of the "management approach" model for segment reporting. Under this model, segment reporting is consistent with the way Company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
The Company has four reportable segments: (1) barbeque set products, (2) skateboards, (3) Other home appliances and (4) Corporate. These operating segments were determined based on the nature of the products and services offered. Overhead items that are specifically identifiable to a particular segment are applied to such a segment.

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. The Company's chief executive officer and chief financial officer have been identified as the chief decision makers. The Company's chief operation decision makers direct the allocation of resources to operating segments based on the profitability and cash flows of each respective segment.

The Company evaluates performance based on several factors, of which the primary financial measure is business segment income before taxes.
 
   
Barbeque set
   
Skateboards
   
Other home appliances
   
Corporate
   
Total
 
   
For the
three
months ended June 30, 2008
   
For the
three
months ended June 30, 2007
   
For the
three
months ended June 30, 2008
   
For the
three
months ended June 30, 2007
   
For the
three
months ended June 30, 2008
   
For the
three
months
ended June 30, 2007
   
For the
three
months
ended June
30, 2008
   
For the
three
months ended June 30, 2007
   
For the
three
months ended June 30, 2008
   
For the
three
months
ended June
30, 2007
 
Net sales
  $ 3,652,866     $ 11,226,912     $ 3,125,721     $ -     $ 1,796,531     $ -     $ -     $ -     $ 8,575,118     $ 11,226,912  
Depreciation and amortization
  $ 59,841     $ 68,665     $ 94     $ -     $ 42,314     $ -     $ -     $ -     $ 102,249     $ 68,665  
Segment (loss)income  before income taxes
  $ (117,911 )   $ 908,780     $ 45,625     $ -     $ 76,807     $ -     $ (282,651 )   $ (242,977 )   $ (278,130 )   $ 665,803  
Capital expenditures
  $ 23,476     $ 160,887     $ -     $ -     $ 6,267     $ 1,639,387     $ -     $ -     $ 29,743     $ 1,800,274  
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
   
Barbeque set
   
Skateboards
   
Other home appliances
   
Corporate
   
Total
 
   
For the
six
 months ended June 30, 2008
   
For the
six
months
 ended June
30, 2007
   
For the
six
months ended June 30, 2008
   
For the
six
months ended June 30, 2007
   
For the
six
months ended June 30, 2008
   
For the
six
months ended June 30, 2007
   
For the
six
months
ended June 30, 2008
   
For the
six
months
 ended June 30, 2007
   
For the
six
months ended June 30, 2008
   
For the
six
months
ended June 30, 2007
 
Net sales
  $ 9,085,357     $ 22,943,679     $ 4,308,298     $ -     $ 2,859,952     $ -     $ -     $ -     $ 16,253,607     $ 22,943,679  
Depreciation and amortization
  $ 132,202     $ 133,084     $ 188     $ -     $ 116,922     $ -     $ -     $ -     $ 249,312     $ 133,084  
Segment (loss)income  before income taxes
  $ (1,611,127 )   $ 1,911,753     $ 141,431     $ -     $ (57,353 )   $ -     $ (535,796 )   $ (242,977 )   $ (2,062,845 )   $ 1,668,776  
Capital expenditures
  $ 47,865     $ 230,218     $ -     $ -     $ 10,601     $ 1,639,387     $ -     $ -     $ 58,466     $ 1,869,605  
                                                                                 
   
As of
June 30,
2008
   
As of December 31, 2007
   
As of
June 30,
2008
   
As of December 31, 2007
   
As of
June 30,
2008
   
As of December 31, 2007
   
As of
June 30,
2008
   
As of December 31, 2007
   
As of
June 30,
2008
   
As of December 31, 2007
 
                                                                                 
Segment assets
  $ 13,248,540     $ 13,009,322     $ 2,803,048     $ 7,894,668     $ 5,313,375     $ 2,274,377     $ 7,208,205     $ 8,711,268     $ 28,573,168     $ 31,889,635  

NOTE 13 – SHIPPING AND HANDLING FEES AND COSTS

The Company follows Emerging Issues Task Force (“EITF”) No. 00-10, Accounting for Shipping and Handling Fees and Costs.  The Company does not charge its customers for shipping and handling.  The Company classifies shipping and handling costs as part of the cost of goods sold which are $300,669 and $264,019 for the six months ended June 30, 2008 and 2007, and $136,478 and $179,213 for the three months ended June 30, 2008 and 2007.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 14 – TRADE DEPOSITS

Amount represents deposits held by suppliers to be used for future purchases.

NOTE 15 – DUE TO STOCKHOLDER

Amount represents advances from a stockholder as at June 30, 2008.  The amount due is unsecured with no stated interest. Amount of $600,000 is not repayable within twelve months from the balance sheet date which recorded under non-current liabilities and the remaining amount of $ 856,869 is repayable on demand which recorded under current liabilities.

NOTE 16 – STOCK OPTIONS

The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of an award, with the following assumptions: no dividend yield, expected volatility of 161%, and a risk-free interest rate of 4.2%. In determining volatility of the Company’s options, the Company used the average volatility of the Company’s stock.

On August 7, 2007, the Company granted to the audit committee chairman and a director of the Company an option to purchase 100,000 shares of the Company’s common stock at an exercise price of $6.00 per share.  One-third of the option vested immediately, with the remaining portion vesting as follows: one-third on July 7, 2008 and one-third on July 7, 2009. The vesting of the option is contingent on continued participation as a Board of Director. The option expires in ten years. Based on the Black-Scholes option pricing model, the entire option was valued at $204,054. One-third of the value of the issuance was expensed immediately as it vested, with the remaining amount expensed monthly over the vesting period. By a resolution of all directors dated April 29 2008, the service agreement with the chairman of the audit committee was terminated.  Accordingly, 16,667 option shares not yet vested will be cancelled.

The following table summarizes all Company stock option transactions between January 1, 2008 and June 30, 2008:

   
Share options
under option
scheme
   
Provision of
option shares
   
Exercise Price
per Common
Share Range
 
Balance, January 1, 2008
    100,000       50,000     $ 6.00  
Written back on termination of services
    (66,667 )     (16,667 )     6.00  
Balance, June 30, 2008
    33,333       33,333          

The following table provides certain information with respect to the above referenced options outstanding at June 30, 2008:

Exercise Price
 
Weighted Average
Exercise Price
 
Weighted Average Remaining
Contractual Life Years
         
$6
 
$6
 
9.1
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 17 – NOTE RECEIVABLE ON STOCK ISSUANCE

The amount represents a promissory note received on May 4, 2006 for the issuance of 5,500,000 shares (post reverse stock split) of the Company’s common stock.  The note receivable is reflected as a contra equity account since the proceeds have not been received as of the issuance of the financial statements. The payment of the promissory note is required when the registration statement covering the 5,500,000 shares is declared effective by the Securities and Exchange Commission.

NOTE 18– INCOME TAXES

The Company utilizes the asset and liability method of accounting for income taxes in accordance with SFAS No. 109. No United States Income Tax and Hong Kong Profits Tax have been provided in the financial statements as no income was arised from the United States and Hong Kong companies during the period.

Well Profit being a foreign venture enterprise in the PRC is entitled to, starting from the first profitable year, a two-year exemption from enterprise income tax followed by a three-year 50% reduction in its enterprise income tax rate (“Tax Holiday”). As such, after the application by Well Profit and approval by the relevant tax authority in 2007, Well Profit was exempted from enterprise income tax for the fiscal years 2007 and 2008.  For the following three fiscal years from 2009 to 2011, Well Profit will be subject to enterprise income tax at rate of 15%.

No provision for deferred taxes assets in respect of unutilized tax losses has been made due to the unpredictability of future profit streams.

NOTE 19 – WARRANTY

The Company accrues an estimate of its exposure to warranty claims based on both current and historical product sales data and warranty costs incurred. The Company assesses the adequacy of its recorded warranty liability annually and adjusts the amount as necessary.  The warranty liability is included in accrued expenses in the accompanying balance sheet.    During the three months ended June 30, 2008, the Company decided not to provide the warranty and guarantee to the customers since the Company provided good quality products to customers. As at June 30, 2008, there is no warranty liability recorded in the balance sheet.  Changes in the Company’s warranty liability were as follows:

   
Six months ended June 30, 2008
   
Six months ended June 30, 2007
 
Warranty accrual, beginning of period
  $ 22,688     $ 24,025  
Warranty accrued during the period
    -       109,200  
Adjustments to pre-existing accruals
    (19,727 )     -  
Actual warranty expenditures
    -       (26,265 )
 
Warranty, end of period
  $ 2,961     $ 106,960  

NOTE 20 – CONCENTRATIONS, RISK AND UNCERTAINTIES

The Company has the following concentrations of business with each customer constituting greater than 10% of the Company’s sales:

   
Three months ended
June 30
   
Six months ended
June 30
 
   
2008
   
2007
   
2008
   
2007
 
Company A
    98 %     68 %     97 %     50 %
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
The Company has the following concentrations of accounts receivable constituting greater than 10% of the Company’s accounts receivable:

   
As at June 30,
 
   
2008
   
2007
 
Company A
    89 %     21 %

This concentration makes the Company vulnerable to a near-term severe impact should the relationships be terminated.

The Company has the following concentrations of business with each supplier constituting greater than 10% of the Company’s purchases:

   
Three months ended
June 30
   
Six months ended
June 30
 
   
2008
   
2007
   
2008
   
2007
 
Company B
    26 %     -       23 %     -  
Company A
    -       72 %     -       55 %
Company C
    -       3 %     -       11 %


NOTE 21 –FIXED PRICE STANDBY EQUITY DISTRIBUTION AGREEMENT

On May 23, 2007, the Company entered into a Fixed Price Standby Equity Distribution Agreement with four investors (the “Investors”).  Pursuant to the Fixed Price Standby Equity Distribution Agreement, the Company may, at its discretion, periodically sell to the Investors up to 10 million shares of the Company’s common stock for a total purchase price of up to $40 million (a per share purchase price of $4.00 per share). The Investors’ obligation to purchase shares of common stock under the Fixed Price Standby Equity Distribution Agreement is subject to certain conditions, including the Company obtaining an effective registration statement for the resale of the common stock sold under the Fixed Price Standby Equity Distribution Agreement.  The investors shall deliver 16.5% of the purchase price payable by wire transfer of immediately available funds to an account that the Company designated in writing to each investor prior to the closing date of the transactions. Also, the investors shall deliver to the Company an executed Promissory Note for the payment of the remaining 83.5% of the remaining commitment under this agreement.

On February 7, 2008, the Company cancelled the Fixed Price Standby Equity Distribution Agreement with the investors and the amount received to be refunded has been reflected as “Notes Payable”.
 
 
HOME SYSTEM GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 22 – COMMITMENTS AND CONTINGENCIES

Operating Leases

In the normal course of business, the Company leases office and factory space under operating lease agreements. The Company rents factory premises for the production and manufacturing process. The operating lease agreements generally contain renewal options that may be exercised at the Company's discretion after the completion of the base rental terms. In addition, many of the rental agreements provide for regular increases to the base rental rate at specified intervals, which usually occur on an annual basis. The Company was obligated under operating leases requiring minimum rentals as follows:

   
As of
 
   
June 30, 2008
 
December 31,
     
2008
  $ 378,510  
2009
    751,264  
2010
    748,385  
2011
    436,840  
2012
    47,589  
         
    $ 2,362,588  

Rental expenses were $184,031 and $94,970 for the three months ended June 30, 2008 and 2007. Rental expenses were $358,575 and $230,479 for the six months ended June 30, 2008 and 2007, respectively.

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The following discussion should be read in conjunction with the Financial Statements and Notes thereto appearing elsewhere in this Form 10-Q.

 
Safe Harbor Regarding Forward-Looking Statements
 
The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 relating to future events or our future performance. Actual results may materially differ from those projected in the forward-looking statements as a result of certain risks and uncertainties set forth in this prospectus. Although management believes that the assumptions made and expectations reflected in the forward-looking statements are reasonable, there is no assurance that the underlying assumptions will, in fact, prove to be correct or that actual results will not be different from expectations expressed in this report.

Overview
 
Home System Group is a Nevada holding company with two China-based operating subsidiaries, Oceanic International (Hong Kong), Ltd., a Hong Kong company, or OCIL, and Oceanic Well Profit, Inc., a PRC company, or Well Profit.  OCIL and Well Profit are primarily engaged in the production of a variety of small household appliances, including stainless steel gas grills and ovens, gas and electric heaters and residential water pumps.  OCIL sales are mainly derived from exports, whereas Well Profit’s sales are largely derived from PRC manufacturing operations.  Our products are sold through distributors to retailers in the United States, Europe, Australia and China.
 
The Company’s financial statements have been prepared on the basis that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. The Company had net loss of $2,062,845 for the six months ended June 30, 2008 and at that date, the Company also had an accumulated deficit of $1,912,684 and current liabilities exceeded current assets by $1,595,873.

Operations to date have been primarily financed by stockholder advances and private equity investments. As a result, the Company's future operations are dependent upon the identification and successful completion of permanent equity investment and/or financing, the continued support of shareholders and ultimately, the achievement of profitable operations.

Results of Operations 
 
Results of Operations
 
Comparison of Three-Month and Six-Month Periods ended June 30, 2008 and June 30, 2007
 
The following table summarizes the results of our operations during the three-month and six-month periods ended on June 30, 2008 and 2007, and provides information regarding the dollar and percentage increase or (decrease) of the three-month and six-month periods ended June 30, 2008, compared to the three-month and six-month periods ended on June 30, 2007.  
 
(all amounts, other than percentages, in U.S. dollars)

   
Three-Month
   
Three-Month
   
Dollar ($)
Percentage
 
   
Period Ended
   
Period Ended
   
Increase
Increase
 
   
June 30, 2008
   
June 30, 2007
   
(Decrease)
(Decrease)
 
                   
Sales revenue
    8,575,118       11,226,912       (2,651,794 )     (23.6 %)
Costs of goods sold
    8,124,279       9,783,876       (1,659,597 )     (17.0 %)
Gross profit
    450,839       1,443,036       (992,197 )     (68.8 %)
General and administrative expenses
    780,236       784,488       (4,252 )     (0.5 %)
Income from operation
    (329,397 )     658,548       (987,945 )          (150.0
%)
Other income
    51,267       7,255       44,012       606.6 %
Net income (loss)
    (278,130 )     664,412       (942,542 )     (141.9 %)

 
(All amounts, other than percentages, in U.S. dollars)

   
Six-Month
   
Six-Month
   
Dollar ($)
   
Percentage
 
   
Period Ended
   
Period Ended
   
Increase
   
Increase
 
   
June 30, 2008
   
June 30, 2007
   
(Decrease)
   
(Decrease)
 
                         
Sales revenue
    16,253,607       22,943,679       (6,690,072 )     (29.2 %)
Costs of goods sold
    16,772,303       19,942,630       (3,170,327 )     (15.9 %)
Gross profit
    (518,696 )     3,001,049       (3,519,745 )     (117.3 %)
General and administrative expenses
    1,617,324       1,339,709       277,615       20.7 %
Income from operation
    (2,102,011 )     1,661,340       (3,763,351 )     (226.5 %)
Other expense
    39,166       7,436       31,730       426.7 %
Net income (loss)
    (2,062,845 )     1,596,293       (3,659,138 )     (229.2 %)
 
 
Sales Revenue. We generated revenues of $8,575,118 for the three months ended June 30, 2008, a decrease of $2,651,794 (or approximately 23.6%), compared to $11,226,912 for the three months ended June 30, 2007. The decrease in revenue was primarily attributable to revenue reduction from OCIL, our exporting subsidiary.  The strict exporting regulation adversely affected our overseas deliveries.  Additionally, the slow US economy also constrains our customers’ purchase abilities, which negatively affected demand for our products.  We expect this trend to continue in the third quarter of 2008.
 
Sales Revenues were $16,253,607 for six months ended June 30, 2008, a decrease of $6,690,072 (or approximately 29.2%) from revenues of $22,943,679 for the six months ended June 30, 2007. The decrease of sales revenues for six months ended June 30, 2008 was primarily due to revenue reduction from OCIL, one of our subsidiaries; additionally, Well Profit, the other subsidiary, experienced a decline in sales due to its focus on the restructure and consolidation of its production lines in order to enhance producing efficiency for the first half of year 2008, which negatively affected its ability to negotiate additional orders. The restructuring and consolidating activities are complete; therefore, the company expects that in the second half of year 2008, this subsidiary will begin increasing sales.  
 
Costs of Sales. The cost of sales was $8,124,279 in the three months ended June 30, 2008, a decrease of $1,659,597 (or approximately 17.0%) from the cost of sales of $9,783,876 in the three months ended June 30, 2007.  The decrease was primarily due to the decrease in our sales volumes.

 
The cost of sales was $16,772,303 for six months ending June 30, 2008, a decrease of $3,170,327 (or approximately 15.9%) from the cost of sales of $19,942,630 for the six months ended June 30, 2007.  The decrease in the cost of our sales resulted primarily from the decrease in our sales volumes and an increase in raw material cost.
 
Gross Profit.  Our gross profit for the three months ended June 30, 2008 was $450,839, compared to $1,443,036 for the three months ended June 30, 2007, a decrease of $992,197, or 68.8%. Our gross profit margin for the three months ended June 30, 2008 was 5.3%, compared to 12.9% for three months ended June 30, 2007.  
 
Our gross profit for the six months ending June 30, 2008 was $(518,696), compared to $3,001,049 for the six months ended June 30, 2007; there is a decrease of $3,519,745, or 117.3%.  Gross profit margin for the six months ended June 30, 2008 was, (3.2%), compared to 13.1% for the same period in 2007. Both decreases were due to the decrease in sales volumes and an increase in raw material cost. 
 
General and Administrative Expenses. General and administrative expenses consist of the costs associated with staff and support personnel who manage our business activities and professional fees paid to third parties.  General and administrative expenses were $780,236 for the three months ended June 30, 2008, a decrease of $4,252 (or approximately 0.5%) from $784,488 incurred during the three months ended June 30, 2007. The Gerneral and Administrative Expenses are relatively fixed; therefore, compared the Gerneral and Administrative Expenses of 2007 with 2008, there is no significant change.
 
General and administrative expenses were $1,617,324 for the six months ended June 30, 2008, an increase of $277,615 (or approximately 20.7%) from the general and administrative expenses of $1,339,709 during the comparable period in 2007. This increase was mainly due to the compensation expense associated with a bonus of double salary to all employees as a Chinese New Year bonus paid during the first quarter of 2008.
 
Income from Operations. Loss from operations was $329,397 during the three months ended June 30, 2008, a decrease of $987,945 from the income from operations of $658,548 during the three months ended June 30, 2007.
 
For the six months ended June 30, 2008, loss from operations was $2,102,011, an decrease of $3,763,351 from income from operations of $1,661,340 during the comparable period in 2007.  
 
Other Income. Other income was $51,267 for the three months ended June 30, 2008, an increase of $44,012 from $7,255 for the three months ended June 30, 2007.  Other income was $39,166 for the six months ended June 30 2008, an increase of $31,730 from $7,436 during the comparable period of 2007. The increase is primarily due to income associated with losses from the sale of company’s leftover raw material. 
 
Net Income (Loss). Net loss of $278,130 was incurred for the three months ended June 30, 2008; a decrease of $942,542 from net income of $664,412 earned during the three months ended June 30, 2007. Net loss of $2,062,845 was incurred for the six months ended June 30, 2008, a decrease of $3,659,138 from net income of $1,596,293 earned in the comparable period of 2007. The decreases in net income was primarily due to the reasons mentioned above.
 
Working Capital Requirements 
 
Historically operations, short term financing and the sale of our company stock have been sufficient to meet our cash needs.  Recent operating losses have placed in increased burden on our need for working capital.  The company believes that its cash balances are sufficient to fund operations until the company generates operating gain in the future.  However, our actual working capital needs for the long and short term will depend upon numerous factors, including operating results, competition, and the availability of credit facilities, none of which can be predicted with certainty. Future expansion will be limited by the availability of financing products and raising capital.


Liquidity and Capital Resources
 
Cash has historically been generated from operations. Operations and liquidity needs are funded primarily through cash flows from operations and short-term borrowings. Cash and cash equivalents were $215,094 at June 30, 2008 and current assets totaled $14,374,607 at June 30, 2008. The Company's total current liabilities were $15,970,480 at June 30, 2008. During the six months ended June 30, 2008 and 2007, net cash provided by (used in) operating activities were $(176,212) and $9,991,514, respectively.

Net cash used in investing activities totaled $58,466 for the six months ended June 30, 2008, compared with $1,813,625 for the same period ended June 30, 2007.

Net cash used in financing activities totaled $397,833 for the six months ended June 30, 2008 compared with $644,315 for the same period ended June 30, 2007. The net cash change was $605,980 decrease and $1,845,049 increase for the six months ended June 30, 2008 and 2007, respectively.

We will continue to evaluate alternative sources of capital to meet our growth requirements, including other asset or debt financing, issuing equity securities and entering into other financing arrangements. There can be no assurance, however, that any of the contemplated financing arrangements described herein will be available and, if available, can be obtained on terms favorable to us.
 
 
 
Item 3.  Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to certain market risks, including changes in interest rates and currency exchange rates.  The Company does not undertake any specific actions to limit those exposures.
 
 Item 4T. Evaluation of Disclosure Controls and Procedures

 
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including to the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
As required by Rule 13a-15 under the Exchange Act, under the supervision and with the participation of our management, including Weiqiu Li our President and Chief Executive Officer and Kinwai Cheung, our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2008. Based on that evaluation, Messrs. Li and Cheung concluded that because of the material weakness in internal control over financial reporting described below, our disclosure controls and procedures were not effective as of June 30, 2008.
 
Changes in Internal Control Over Financial Reporting
 
There were no changes in our internal control over financial reporting identified in connection with the evaluation performed that occurred during the fiscal quarter covered by this report that has materially affected or is reasonably likely to materially affect, our internal control over financial reporting.
 
Management’s Report on Internal Controls over Financial Reporting
 
 
In connection with their review of our internal controls over financial reporting for the fiscal year ended December 31, 2007, our management concluded that there were several significant deficiencies, that when combined, resulted in a material weakness in our internal controls over our ability to produce financial statements free from material misstatements. The material weakness resulted from a combination of the following significant deficiencies:
 
 
·  
Lack of documentation and review of financial information by our accounting personnel with direct oversight responsibility, and lack of analysis and reconciliation of certain accounts on a periodic basis, and the failure of the accounting system to provide information related to expenditures on a project-by-project basis;
 
 
·  
Lack of timely identification, research and resolution of accounting issues and lack of documentation of consideration of recent accounting pronouncements;
 
 
·  
Absence of documented controls over our related party transactions; and
 
 
·  
Lack of technical accounting expertise among senior financial staff regarding US GAAP and the requirements of the PCAOB, and regarding the preparation of draft financial statements.
 
In order to further enhance our internal controls, our management, with the participation of Messrs. Li and Cheung, has recommended the implementation of the following changes by the end of fiscal year 2008:
 
·  
the restructuring of our relationships with related parties to address our controls over related party transactions;
 
 
·  
the hiring of additional accounting personnel to assist us in the timely identification, research and resolution of accounting issues and with our documentation processes;
 
 
·  
the hiring of additional high-level accounting personnel with experience in US GAAP to monitor all financial and accounting affairs throughout the Company; and
 
 
·  
the engagement of a third-party financial consulting firm to assist management in evaluating complex accounting issues on an as-needed basis, and the implementation of systems to improve control and review procedures over all financial statement and account balances.
 
We expect that these steps, when taken, will correct the material weaknesses described above. We do not believe that the costs of remediation for the above material weaknesses will have a material effect on our financial position, cash flow, or results of operations.
 

PART II - OTHER INFORMATION
Item 1.    Legal Proceedings.
 
None.

Item 1A.    Risk Factors.
 
RISKS RELATED TO OUR BUSINESS
 
The increasing concentration of our small electric household appliance sales among a few retailers and the trend toward private-label brands could negatively affect sales levels or profits.
 
With the growing trend towards the concentration of our small electric household appliance sales among a few retailers, our distributors are increasingly dependent upon fewer customers whose bargaining strength is growing as a result of concentration.  Through our distributors a substantial quantity of our products to mass merchandisers, national department stores, variety store chains, drug store chains, specialty home retailers and other retail outlets.  These retailers generally purchase a limited selection of small electric household appliances.  As a result, we compete for retail shelf space with our competitors.  In addition, certain of our larger customers are using their own private label brands on household appliances that compete directly with some of our products.  As the retailers in the small electric household appliance industry become more concentrated, competition for sales to these retailers may increase, which could adversely affect our results of operations.
 
 
We are susceptible to a material decrease in business if end-users of our products decide not to utilize our distributors.
 
The customers of our distributors might utilize the services of a different distributor or they might directly import the products themselves from other manufacturers.  If our distributors were to lose one of their major customers our revenues will materially decrease.
 
Our business could be adversely affected by retailer inventory management.
 
Changes in retailer inventory management strategies could make inventory management more difficult for us. As a result of the desire of retailers to more closely manage inventory levels, there is a growing trend among retailers to make purchases on a “just-in-time” basis. This requires us to shorten our lead time for production in certain cases and more closely anticipate demand, which could in the future require the carrying of additional inventories or require us to incur additional expenses to expedite delivery.  If our end customers significantly change their inventory management strategies or if they or we fail to forecast consumer demand accurately, we may encounter difficulties in filling the orders placed by our distributors or in liquidating excess inventories, or may find that customers are canceling orders or returning products.  Distribution difficulties may have an adverse effect on our business by increasing the amount of inventory and the cost of warehousing inventory.  Any of these results could have a material adverse effect on us.
 
 
We rely on only a few suppliers for the bulk of our raw materials and their non-performance would adversely affect our operations.
 
We obtain a majority of our products from only a few suppliers whose nonperformance would have a near-term severe impact on our operations.  This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.   Such failure could cause us to experience delivery delays or failures caused by production issues or could cause us to deliver of non-conforming products.
 
We rely on three customers for the majority of our sales revenues and should their orders decrease or their relationship with us be terminated our business and operations would be adversely affected.
 
Well Profit sells the vast majority of its products to Hengbao, Rich Empire and Baochang, its exclusive distributors, through an unwritten commercial arrangement between Well Profit and each of them.  Hengbao is indirectly owned by Oceanic PRC, which until March 2007, was indirectly owned and controlled by Mr. Weiqiu Li, our director and Chief Executive Officer.  During the fiscal year ended December 31, 2007, Hengbao, Rich Empire and Baochang were responsible for 69%, 22% and 5%, respectively, of Well Profit’s sales revenues.  In addition, for the fiscal years ended December 31, 2007 and 2006, our sales to Hengbao, Rich Empire and Baochang accounted for $8,772,569, or 97% of our receivables, all of which remains outstanding as at December 31, 2007, with no stated interest rate or repayment terms.  Since Well Profit accounted for 71% of our sales during the fiscal year ended December 31, 2007, its concentration of sales with Hengbao, Rich Empire and Baochang makes us vulnerable to any changes in the business environment in which they operate.  Any adverse effects on their business and operations may adversely affect our business and operations.
 
The small electric household and appliance industry is consolidating, which could have a material adverse impact on our success.
 
Over the past several years, the small electric household and appliance industry has undergone substantial consolidation, and further consolidation is likely.  As a result of this consolidation, the small electric household and appliance industry could largely consist of a limited number of large distributors.  To the extent that we do not continue to be a major participant in the small electric household and appliance industry, our ability to compete effectively with these larger distributors could be negatively impacted. As a result, our results of operations could be materially adversely affected.
 
 
Competition may materially adversely affect our results of operations.
 
The small electric household and appliance industry does not have onerous entry barriers.  As a result, we compete with many small manufacturers and distributors of household products.  Additional competitors may also enter this market and cause competition to intensify.  We believe that competition is based upon several factors, including product design and innovation, quality, price, product features, merchandising, promotion and warranty. If we fail to compete effectively with these manufacturers and distributors, our results of operations could be materially adversely affected.
 
We also compete with established companies, a number of which have substantially greater facilities, personnel, financial and other resources than we have.  In addition, we compete with our retail customers, who use their own private label brands, and with exporters and foreign manufacturers of unbranded products.  Some competitors may be willing to reduce prices and accept lower profit margins to compete with us.  As a result of this competition, we could lose market share and sales, or be forced to reduce our prices to meet competition.
 
We depend on consumer spending, which fluctuates for a variety of reasons, including seasonality.
 
Sales of our products are related to consumer spending.  Any downturn in the general economy or a shift in consumer spending away from small electric household appliances would adversely affect our business. In addition, the market for small electric household appliances is highly seasonal in nature. We often recognize a substantial portion of our sales during the third and fourth quarters of the fiscal year due to increased demand by consumers in late summer and fall for the Holiday season.  Any economic downturn, decrease in consumer spending or a shift in consumer spending away from small electric household appliances could materially adversely impact our results of operations.
 
The failure of our business strategy could have a materially adverse effect on our business.
 
As part of our business strategy, we plan to:
 
·  
continue cost reductions throughout the entire company and at our suppliers;
·  
reduce product returns and improve the quality of our products;
·  
pursue innovation in our product categories through our ability to research, design and test new product concepts; and
·  
develop and sustain industry-leading sales, marketing and branding programs in our industry.
 
Our strategic objectives may not be realized or, if realized, may not result in increased revenue, profitability or market presence. Executing our strategy may also place a strain on our suppliers, information technology systems and other resources. To manage growth effectively, we must maintain a high level of quality, properly manage our third-party suppliers, continue to enhance our operational, financial and management systems and expand, train and manage our employee base. We may not be able to effectively manage our growth in any one or more of these areas, which could have a materially adverse effect on our business.
 
Our future success depends on the development of new and innovative products on a consistent basis in order to increase revenues and we may not be able to do so.
 
We believe that our future success is heavily dependent upon our ability to continue to make innovations in our existing products and to develop, source and market new products, which generally carry higher margins. We may not be successful in the introduction, marketing and sourcing of any new products or product innovations and we may not be able to develop and introduce in a timely manner innovations to our existing products that satisfy customer needs or achieve market acceptance.
 
Our business can be adversely affected by newly acquired businesses or product lines.
 
We will continue to acquire partial or full ownership in businesses and may acquire rights to market and distribute particular products or lines of products.  The acquisition of a business or of the rights to market specific products or use specific product names usually involve a financial commitment by us, either in the form of cash or stock consideration.  In the case of a new license, such commitments are usually in the form of prepaid royalties and future minimum royalty payments.  We may not be able to acquire businesses and develop products that will contribute positively to our earnings.  Anticipated synergies may not materialize, cost savings may be less than expected, sales of products may not meet expectations and acquired businesses may carry unexpected liabilities.
 
 
Government regulations could adversely impact our operations.
 
Throughout the world, electrical appliances are subject to various mandatory and voluntary safety standards, including requirements in certain jurisdictions that products be listed by Underwriters Laboratories, Inc. or other such recognized laboratories. Many foreign, federal, state and local governments also have enacted laws and regulations that govern the labeling and packaging of products and limit the sale of product containing certain materials deemed to be environmentally sensitive. Our products may be found to be noncompliant. A determination that we are not in compliance with such rules, regulations or standards could result in the imposition of fines or an award of damages to private litigants.
 
Environmental regulations impose substantial costs and limitations on our operations.
 
We are subject to various national and local environmental laws and regulations in China concerning issues such as air emissions, wastewater discharges, and solid waste management and disposal.  These laws and regulations can restrict or limit our operations and expose us to liability and penalties for non-compliance.  While we believe that our facilities are in material compliance with all applicable environmental laws and regulations, the risks of substantial unanticipated costs and liabilities related to compliance with these laws and regulations are an inherent part of our business.  It is possible that future conditions may develop, arise or be discovered that create new environmental compliance or remediation liabilities and costs.  While we believe that we can comply with existing environmental legislation and regulatory requirements and that the costs of compliance have been included within budgeted cost estimates, compliance may prove to be more limiting and costly than anticipated.
 
Our business involves the potential for product recalls and product liability claims.
 
As distributors of consumer products to consumers in the United States, we are subject to the Consumer Products Safety Act, which empowers the U.S. Consumer Products Safety Commission to exclude from the market products that are found to be unsafe or hazardous. Under certain circumstances, the U.S. Consumer Products Safety Commission could require us to repair, replace or refund the purchase price of one or more of our products, or we may voluntarily do so.  If we were required to remove, or we voluntarily remove, our products from the market, our reputation or brands could be tarnished and we might have large quantities of finished products that could not be sold.  Furthermore, failure to timely notify the U.S. Consumer Product Safety Commission of a potential safety hazard can result in fines being assessed against us.  Additionally, laws regulating certain consumer products exist in some states, as well as in other countries in which we sell our products, and more restrictive laws and regulations may be adopted in the future. We also face exposure to product liability claims if one of our products is alleged to have caused property damage, bodily injury or other adverse effects. We are self-insured to specified levels of those claims.
 
Our results of operations are also susceptible to adverse publicity regarding the quality and safety of our products. In particular, product recalls or product liability claims challenging the safety of our products may result in a decline in sales for a particular product. This could be true even if the claims themselves are ultimately settled for immaterial amounts. This type of adverse publicity could occur and product liability claims could be made in the future.
 
If we grow through acquisitions and fail to successfully integrate acquired companies, our operations could be disrupted and management could become distracted by integration issues.
 
As part of our business strategy, we plan to grow in part by acquiring other product lines, technologies or facilities that complement or expand our existing business.  We may be unable to implement this part of our business strategy and may not be able to continue making acquisitions to continue our growth.  There is significant competition for acquisition targets in the small household appliance industry.  We may not be able to identify suitable acquisition candidates or negotiate attractive terms.  In addition, we may have difficulty obtaining the financing necessary to complete transactions that we pursue.  Future acquisitions may involve the issuance of our equity securities as payment, in part or in full, for the businesses or assets acquired.  Any future issuances of equity securities would dilute your ownership interests.  In addition, future acquisitions might not increase, and may even decrease, our earnings or earnings per share and the benefits derived by us from an acquisition might not outweigh or might not exceed the dilutive effect of the acquisition.  We also may incur additional debt or suffer adverse tax and accounting consequences in connection with any future acquisitions, although we currently do not have any identified future acquisition targets.
 
 
Where we are successful in completing acquisitions, we might experience difficulties in integrating the acquired business or assets. Acquisitions might result in unanticipated liabilities, unforeseen expenses and distraction of management’s time and attention. We cannot assure you that our acquisition strategy will be successful.
 
Expansion of our business may put added pressure on our management and operational infrastructure impeding our ability to meet any increased demand for our products and possibly hurting our operating results.
 
Our business plan is to significantly grow our operations to meet anticipated growth in demand for existing products, and by the introduction of new product offerings.  Our planned growth includes the construction of new production lines to be put into operation over the next twelve months.  Growth in our business may place a significant strain on our personnel, management, financial systems and other resources.  The evolution of our business also presents numerous risks and challenges, including:
 
·  
our ability to successfully and rapidly expand sales to potential customers in response to potentially increasing demand;
·  
the costs associated with such growth, which are difficult to quantify, but could be significant; and
·  
rapid technological change.
 
To accommodate any such growth and compete effectively, we may need to obtain additional funding to improve information systems, procedures and controls and expand, train, motivate and manage our employees, and such funding may not be available in sufficient quantities, if at all.  If we are not able to manage these activities and implement these strategies successfully to expand to meet any increased demand, our operating results could suffer.
 
We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.
 
Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, particularly Kinwai Cheung, our Chief Financial Officer and Weiqiu Li, our Chief Executive Officer.  They also depend in significant part upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations.  If we lose a key employee or if a key employee fails to perform in his or her current position, or if we are not able to attract and retain skilled employees as needed, our business could suffer.  Significant turnover in our senior management could significantly deplete our institutional knowledge held by our existing senior management team.  We do not maintain key man life insurance on any of these individuals.  We depend on the skills and abilities of these key employees in managing the manufacturing, technical, marketing and sales aspects of our business, any part of which could be harmed by further turnover.
 
We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have the operating effectiveness of our internal controls attested to by our independent auditors.
 
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, the SEC adopted rules requiring public companies to include a report of management on the company’s internal controls over financial reporting in their annual reports on Form 10-K.  In addition, SOX 404 requires the independent registered public accounting firm auditing a company’s financial statements to also attest to and report on the operating effectiveness of such company’s internal controls.  However, this annual report does not include an attestation report because under current law, we will not be subject to these requirements until our annual report for the fiscal year ending December 31, 2008.  We can provide no assurance that we will comply with all of the requirements imposed thereby.  There can be no assurance that we will receive a positive attestation from our independent registered public accountants. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent registered public accountants with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements.
 
 
Investor confidence and market price of our shares may be adversely impacted if we are unable to correct a material weakness in our internal controls over our financial reporting identified by our independent registered public accountants.
 
In connection with their review of our internal controls over financial reporting, our management concluded that there were several significant deficiencies, that when combined, resulted in a material weakness in our internal controls over our ability to produce financial statements free from material misstatements.  This material weakness resulted from the combination of the following significant deficiencies: (a) lack of timely identification, research and resolution of accounting issues and lack of  documentation of consideration of recent accounting pronouncements; (b) lack of documentation and review of financial information by our accounting personnel with direct oversight responsibility, and lack of analysis and reconciliation of certain accounts on a periodic basis, and the failure of the accounting system to provide information related to expenditures on a project-by-project basis; (c) absence of documented controls over our related party transactions; and (d) lack of technical accounting expertise among senior financial staff regarding US GAAP and the requirements of the PCAOB, and regarding the preparation of draft financial statements. Our management has recommended that we address these deficiencies by (1) restructuring of our relationships with related parties to address our controls over related party transactions, (2) hiring additional accounting personnel to assist us in the timely identification, research and resolution of accounting issues and with our documentation processes, (3)  hiring additional high-level accounting personnel with experience in US GAAP to monitor all financial and accounting affairs throughout the Company and (3) engaging a third-party accounting firm to assist management in evaluating complex accounting issues on an as-needed basis.  We believe that these steps will correct the material weaknesses described above, however, our failure to fully remediate it could result in an adverse reaction in the financial marketplace, which could negatively impact the market price of our shares.
 
RISKS RELATED TO DOING BUSINESS IN CHINA
 
Adverse changes in political and economic policies of the PRC  government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.
 
We conduct substantially all of our operations and generate most of our revenue in China.   Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China.  The PRC economy differs from the economies of most developed countries in many respects, including:
 
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the higher level of government involvement;
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the early stage of development of the market-oriented sector of the economy;
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the rapid growth rate;
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the higher level of control over foreign exchange; and
·  
the allocation of resources.
 
As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.
 
Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.
 
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of automotive investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our business and prospects.
 
 
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
 
We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.  In addition, all of our executive officers and all but one of our directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States.  As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
 
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
 
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership.  Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters.  We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements.  However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
 
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
 
Restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively.
 
Most of our sales revenue and expenses are denominated in RMB. Under PRC law, the RMB is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, our PRC operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our future revenue will be denominated in RMB, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in RMB to fund our business activities outside China that are denominated in foreign currencies.
 
Foreign exchange transactions by PRC operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or MOFCOM, or their respective local counterparts. These limitations could affect their ability to obtain foreign exchange through debt or equity financing.
 
 
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.
 
In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in June 2007 (known as Notice 106), expanded the reach of Circular 75 by (i) purporting to cover the establishment or acquisition of control by PRC residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership; (ii) adding requirements relating to the source of the PRC resident’s funds used to establish or acquire the offshore entity; (iii) covering the use of existing offshore entities for offshore financings; (iv) purporting to cover situations in which an offshore SPV establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China; and (v) making the domestic affiliate of the SPV responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds. Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations, and Notice 106 makes the offshore SPV jointly responsible for these filings. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006; this date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.
 
We believe our stockholders who are PRC residents as defined in Circular 75 have registered with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries.  However, we cannot provide any assurances that their existing registrations have fully complied with, and they have made all necessary amendments to their registration to fully comply with, all applicable registrations or approvals required by Circular 75.  Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies.  For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders.  In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75.  We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures.  A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
 
We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations which became effective on September 8, 2006.
 
On August 8, 2006, six PRC regulatory agencies, including the CSRC, promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006.  This new regulation, among other things, governs the approval process by which a PRC company may participate in an acquisition of assets or equity interests.  Depending on the structure of the transaction, the new regulation will require the PRC parties to make a series of applications and supplemental applications to the government agencies.  In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction.  Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies.  Compliance with the new regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses.  Accordingly, due to the new regulation, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our stockholders or sufficiently protect their interests in a transaction.
 
 
The new regulation allows PRC government agencies to assess the economic terms of a business combination transaction.  Parties to a business combination transaction may have to submit to the Ministry of Commerce and other relevant government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction.  The regulations also prohibit a transaction at an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year.  The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities.  Transaction structures involving trusts, nominees and similar entities are prohibited.  Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our stockholders’ economic interests.
 
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
 
The value of our common stock will be indirectly affected by the foreign exchange rate between U.S. dollars and RMB and between those currencies and other currencies in which our sales may be denominated. Because substantially all of our earnings and cash assets are denominated in RMB, appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars and earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
 
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
 
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
 
Currently, some of our raw materials and major equipment are imported.  In the event that the U.S. dollars appreciate against RMB, our costs will increase.  If we cannot pass the resulting cost increases on to our customers, our profitability and operating results will suffer.  In addition, since our sales to international customers are growing rapidly, we are increasingly subject to the risk of foreign currency depreciation.
 
New corporate income tax law could adversely affect our business and our net income.
 
On March 16, 2007, National People's Congress passed a new corporate income tax law, which will be effective on January 1, 2008.  This new corporate income tax unifies the corporate income tax rate, cost deductions and tax incentive policies for both domestic and foreign-invested enterprises in China.  According to the new corporate income tax law, the applicable corporate income tax rate of our Chinese subsidiaries will incrementally increase to 25% over a five-year period.  We are expecting that the rules for implementation would be enacted by the Chinese government in the coming months.  After the rules are enacted, we can better assess what the impact of the new unified tax law would be over this period.  The discontinuation of any special or preferential tax treatment or other incentives could adversely affect our business and our net income.
 
 
RISKS RELATED TO THE MARKET FOR OUR STOCK GENERALLY
 
The market price of our common stock is volatile, leading to the possibility of its value being depressed at a time when you want to sell your holdings.
 
The market price of our common stock is volatile, and this volatility may continue.  For instance, between December 15, 2006 and September 30, 2007, the bid price of our common stock, as reported on the markets on which our securities have traded, ranged between $0.50 and $4.75.