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EX-31.2 - EXHIBIT 31.2 - SORL Auto Parts Incv343438_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SORL Auto Parts Incv343438_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

xQUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended March 31, 2013

 

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

For the transition period from _________ to _________

 

Commission file number 000-11991

 

SORL AUTO PARTS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE 30-0091294
(State or other jurisdiction of incorporation or
organization)
(IRS Employer Identification No.)

 

No. 1169 Yumeng Road

Ruian Economic Development District

Ruian City, Zhejiang Province

People’s Republic Of China

(Address of principal executive offices)


86-577-6581-7720

(Registrant’s telephone number)


Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No £

  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No £

 

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

Large Accelerated Filer £ Accelerated Filer £ Non-Accelerated Filer£ 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 ¨ No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

Indicate the number of shares outstanding of each of the issuer classes of common stock, as of the latest practicable date:

As of March 31, 2013 there were 19,304,921 shares of Common Stock outstanding

  

 
 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Three months ended March 31, 2013

 

INDEX

    Page
     
PART I. FINANCIAL INFORMATION (Unaudited) 1
     
Item 1. Financial Statements: 1
     
  Condensed Consolidated Balance Sheets (Unaudited) as of March 31, 2013 and December 31, 2012 1
     
  Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2013 and 2012 2
     
  Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) for the Three months ended March 31, 2013 and 2012 3
     
  Condensed Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2013 and 2012 4
     
  Notes to the Condensed Consolidated Financial Statements (Unaudited) 5
     
Item 2. Management’s Discussion and Analysis or Financial Condition and Results of Operations 19
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
     
Item 4. Controls and Procedures 25
     
PART II. OTHER INFORMATION 25
     
Item 1.

Legal Proceedings. 

25
     
Item 1A. Risk Factors. 25
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 25
     
Item 3.   Defaults Upon Senior Securities. 25
     
Item 4. Mine Safety Disclosures. 25
     
Item 5.   Other Information. 25
     
Item 6. Exhibits 25
     
SIGNATURES 26

  

 
 

 

SORL Auto Parts, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)

 

    March 31, 2013     December 31, 2012  
             
Assets                
Current Assets                
Cash and cash equivalents   US$ 43,222,310     US$ 41,253,353  
Accounts receivable, net of provision     58,526,889       62,153,509  
Bank acceptance notes from customers     7,611,539       10,098,390  
Inventories     61,714,709       56,775,825  
Prepayments, including $182,948 and $0 due from related parties at March 31, 2013 and December 31, 2012, respectively     5,933,349       5,722,743  
Current portion of prepaid capital lease Interest     593,426       876,326  
Other current assets     2,252,173       1,183,487  
Deferred tax assets     724,593       687,632  
Total Current Assets     180,578,988       178,751,265  
                 
Fixed Assets                
Property, plant and equipment, net     46,872,611       46,962,599  
Leasehold improvements in progress     331,414       335,714  
                 
Land Use Rights, Net     14,853,580       14,742,047  
                 
Other Non-Current Assets                
                 
Intangible assets, net     63,575       66,889  
Security deposits on lease agreement     1,838,958       1,879,831  
Long term deferred expense-prepaid interest     702,345       822,640  
Total Other Non-Current Assets     2,604,878       2,769,360  
Total Assets   US$ 245,241,471     US$ 243,560,985  
                 
Liabilities and Stockholders' Equity                
                 
Current Liabilities                
Accounts payable, including $0 and $94,954 due to related parties at March 31, 2013 and December 31, 2012, respectively   US$ 9,695,756     US$ 14,324,633  
Deposit received from customers     8,487,271       6,599,746  
Short term bank loans     11,044,709       14,599,753  
Accrued expenses     9,117,385       8,501,819  
Current portion of capital lease obligations     3,662,006       10,458,352  
Other current liabilities, including $139,963 and $33,083 due to related parties at March 31, 2013 and December 31, 2012, respectively     289,291       313,006  
Total Current Liabilities     42,296,418       54,797,309  
                 
Non-Current Liabilities                
Non-current portion of capital lease obligations     10,130,178       -  
Deferred tax liabilities     310,153       291,995  
Total Non-Current Liabilities                
                 
Total Liabilities   US$ 52,736,749       55,089,304  
                 
Stockholders' Equity                
                 
Preferred stock - No par value; 1,000,000 authorized; none issued and outstanding as of December 31, 2012 and December 31, 2011     -       -  
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 and 19,304,921 issued and outstanding as of March 31, 2013 and December 31, 2012     38,609       38,609  
Additional paid-in capital     42,199,014       42,199,014  
Reserves     9,806,289       9,676,183  
Accumulated other comprehensive income     24,416,279       22,020,008  
Retained earnings     97,217,680       96,114,407  
Total SORL Auto Parts, Inc. stockholders' equity     173,677,871       170,048,221  
Noncontrolling Interest In Subsidiaries     18,826,851       18,423,460  
Total Equity     192,504,722       188,471,681  
Total Liabilities and Stockholders' Equity   US$  245,241,471     US$  243,560,985  

 

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

 

1
 

  

SORL Auto Parts, Inc. and Subsidiaries
Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)

 

   Three Months Ended March 31, 
   2013   2012 
         
Sales  US$41,318,160    44,598,241 
Include: sales to related parties   238,181    586,789 
Cost of sales   30,141,279    32,381,944 
           
Gross profit   11,176,881    12,216,297 
           
Expenses:          
Selling and distribution expenses   3,361,557    3,170,902 
General and administrative expenses   4,163,146    3,857,757 
Research and development expenses   1,390,464    1,267,156 
           
Other income   295,140    351,845 
Financial expenses   (946,244)   (594,897)
Non-operating expenses   (68,077)   (60,896)
           
Income before provision for income taxes   1,542,533    3,616,534 
           
Provision for income taxes   168,854    1,018,656 
           
Net income before noncontrolling interest & other comprehensive income  US$1,373,679    2,597,878 
           
Net income attributable to noncontrolling interest in subsidiaries   140,300    263,889 
           
Net income attributable to stockholders   1,233,379    2,333,989 
           
Foreign currency translation adjustment   2,659,362    265,862 
           
Noncontrolling interest's share   263,091    30,699 
           
Comprehensive income   3,629,650    2,569,152 
           
Weighted average common share - basic   19,304,921    19,304,921 
           
Weighted average common share - diluted   19,304,921    19,304,921 
           
EPS - basic   0.06    0.12 
           
EPS - diluted   0.06    0.12 

 

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

 

2
 

 

SORL Auto Parts, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
For The Three Months Ended on March 31, 2013

 

   Number
of Share
   Common
Stock
   Additional
Paid-in
Capital
   Reserves   Retained
Earnings
(Deficit)
   Accumu. Other
Comprehensive
Income
    Stockholders'
Equity
    Noncontrolling
Interest
    Total
Equity
 
Beginning Balance - January 1, 2013   19,304,921    38,609    42,199,014    9,676,183    96,114,407    22,020,008    170,048,221    18,423,460    188,471,681 
                                              
Net income   -    -    -    -    1,233,379    -    1,233,379    140,300    1,373,679 
                                              
Other comprehensive income(Loss)   -    -    -    -    -    2,396,271    2,396,271    263,091    2,659,362 
                                              
Transfer to reserve   -    -    -    130,106    (130,106)   -    -    -    - 
                                              
Ending Balance – March 31, 2013   19,304,921    38,609    42,199,014    9,806,289    97,217,680    24,416,279    173,677,871    18,826,851    192,504,722 

  

SORL Auto Parts, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
For The Three Months Ended on March 31, 2012

 

   Number 
of Share
   Common
Stock
   Additional
Paid-in
Capital
   Reserves   Retained
 Earnings
(Deficit)
   Accumu. Other
Comprehensive
Income
    Stockholders'
Equity
    Noncontrolling
Interest
    Total
Equity
 
Beginning Balance - January 1, 2012   19,304,921    38,609    42,199,014    8,375,392    84,610,260    21,910,957    157,134,232    16,947,178    174,081,410 
                                              
Net income   -    -    -    -    2,333,989    -    2,333,989    263,889    2,597,878 
                                              
Other comprehensive income(Loss)   -    -    -    -    -    235,163    235,163    30,699    265,862 
                                              
Transfer to reserve   -    -    -    233,051    (233,051)   -    -    -    - 
                                              
Ending Balance – March 31, 2012   19,304,921    38,609    42,199,014    8,608,443    86,711,198    22,146,120    159,703,384    17,241,766    176,945,150 

  

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

 

3
 

 

SORL Auto Parts, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

   Three Months Ended March 31, 
   2013   2012 
         
Cash Flows from Operating Activities          
Net Income Attributable to Stockholders  US$1,233,379     2,333,989 
Adjustments to reconcile net income to net cash from operating activities:          
Noncontrolling interest in subsidiaries   140,300    263,889 
Allowance for doubtful accounts   221,346    27,775 
Depreciation and amortization   1,992,345    1,939,592 
Loss on disposal of fixed assets   -    2,333 
Changes in Assets and Liabilities:          
Accounts receivable   4,891,616    (648,998)
Bank acceptance notes from customers   2,609,107    6,722,671 
Other currents assets   (1,019,272)   1,461,199 
Inventories   (4,130,237)   2,645,103 
Prepayments   (131,123)    (3,483,826)
Deferred tax assets   (27,212)   (82,017)
Accounts payable and bank acceptance notes to vendors   (5,426,720)   (8,336,880)
Income tax payable   -    463,556 
Deposits received from customers   1,785,251    78,584 
Other current liabilities and accrued expenses   718,541    918,622 
Deferred tax liabilities   14,001    13,912 
Net Cash Flows from Operating Activities   2,871,322    4,319,504 
           
Cash Flows from Investing Activities          
Acquisition of property and equipment   (965,846)   (367,457)
Proceeds of disposal of fixed assets   -    3,096 
Leasehold improvements in progress   -    (31,069)
           
Net Cash Flows from Investing Activities   (965,846)   (395,430)
           
Cash Flows from Financing Activities          
Repayment of bank loans   (3,732,075)   (4,761,199)
Proceeds from capital lease   12,783,841    (559,570)
Repayment of capital lease   (9,550,873)   - 
           
Net Cash flows from Financing Activities   (499,107)   (5,320,769)
           
Effects on changes in foreign exchange rate   562,588    16,038 
           
Net change in cash and cash equivalents   1,968,957    (1,380,657)
           
Cash and cash equivalents- beginning of the year   41,253,353    17,116,692 
           
Cash and cash equivalents - end of the year  US$43,222,310     15,736,035 
           
Supplemental Cash Flow Disclosures:          
Interest paid   613,129    1,473,202 
Tax paid   649,625    3,894,621 

  

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

 

4
 

 

SORL Auto Parts, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

NOTE A - DESCRIPTION OF BUSINESS

 

SORL Auto Parts, Inc. (together with its subsidiaries, “we,” “us,” “our” or the “Company” or “SORL”) is principally engaged in the manufacture and distribution of vehicle brake systems and other key safety-related components, through its 90% ownership of Ruian China and 60% ownership of SORL International Holding, Ltd. ("SIH") in Hong Kong. The Company distributes products both in China and internationally under SORL trademarks. The Company’s product range includes 65 categories and over 2000 different specifications.

 

On November 11, 2009, the Company entered into a joint venture agreement with MGR, a Hong Kong-based global auto parts distribution specialist firm and a Taiwanese investor. The new joint venture was named SIH. SORL holds a 60% interest in the joint venture, MGR holds a 30% interest, and the Taiwanese investor holds a 10% interest. SIH is primarily devoted to expanding SORL's international sales network in Asia-Pacific and creating a larger footprint in Europe, the Middle East and Africa with a target to create a truly global distribution network. Based in Hong Kong, SIH is expanding and establishing channels of distribution in international markets with SORL's primary products, including spring brake chambers, clutch servos, air dryers, relay valves and hand brake valves.

 

On February 8, 2010, the Company sold 1,000,000 shares of its common stock to selected institutional investors at a price of $10.00 per share pursuant to a registered direct offering. This transaction provided net proceeds of approximately $9.4 million. On March 9, 2010, through Fairford, SORL invested $9.349 million in its operating subsidiary, the Joint Venture To maintain its 10% interest in the Joint Venture, the Ruili Group increased its capital investment by USD$1.039 million. Accordingly, SORL continues to hold a 90% controlling interest in the operating subsidiary.

 

On August 31, 2010, the Company, through the Joint Venture, executed an agreement to acquire the assets of the hydraulic brake, power steering, and automotive electrical operations of the Ruili Group ( a related party under common control). As a result of this acquisition, the Company's product offerings expanded to both commercial and passenger vehicles' brake systems and other key safety-related auto parts. The purchase price was RMB 170 million, or approximately USD$25 million. The transaction was accounted for using the book value of assets acquired, consisting primarily of machinery and equipment, inventory, accounts receivable and patent rights, used or usable in connection with the acquired segment of the auto parts business of the Seller. The Company purchased the machinery and equipment, inventory, accounts receivable at book values of $8.0 million, $8.0 million and $5.2 million, respectively. The Company did not acquire any of the assets of the Seller other than those in the segment of Seller's business described above. The excess of consideration over the carrying value of net assets received has been recorded as a decrease in the additional paid-in capital of the Company.

 

The acquisition was accounted for as a transaction between the entities under common control because the CEO of the Company owns 63% of the registered capital of Ruili Group, and owns more than 50% of the outstanding common stock of SORL, together with his wife and brother. This results in the acquisition being accounted for using the historical costs of the financial statements of the Seller. The consolidated financial statements have been prepared as if the acquisition took place at the earliest time presented, that is, as of January 1, 2009. The assets purchase was deemed to be the acquisition of a business.

 

5
 

 

NOTE B - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

(1)BASIS OF PRESENTATION

 

The condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All intercompany balances and transactions have been eliminated in the consolidation. Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted as permitted by the rules and regulations of the United States Securities and Exchange Commission, although the Company believes that the disclosures contained in this report are adequate to make the information presented not misleading. The condensed consolidated balance sheet information as of December 31, 2012 was derived from the audited consolidated financial statements included in Form 10-K. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2012, and other reports filed with the SEC.

 

The accompanying condensed unaudited interim consolidated financial statements reflect all adjustments of a normal and recurring nature which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. The results of operations for these periods are not necessarily comparable to, or indicative of, results of any other interim period or for the fiscal year taken as a whole.

 

(2)SIGNIFICANT ACCOUNTING POLICIES

 

a. ACCOUNTING METHOD

 

The Company uses the accrual method of accounting for financial statement and tax return purposes.

  

b. USE OF ESTIMATES

 

The preparation of financial statements in conformity with U.S generally accepted accounting principles 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 revenues and expenses during the reporting period. Management makes its best estimate of the outcome for these items based on historical trends and other information available when the financial statements are prepared. Changes in estimates are recognized in accordance with the accounting rules for the estimate, which is typically in the period when new information becomes available to management. Actual results could differ from those estimates.

 

c. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

For certain of the Company’s financial instruments, including cash and cash equivalents, trade receivables and payables, prepaid expenses, deposits and other current assets, short-term bank borrowings, and other payables and accruals, the carrying amounts approximate fair values due to their short maturities.

 

d. REVENUE RECOGNITION

 

Revenue from the sale of goods is recognized when the risks and rewards of ownership of the goods have transferred to the buyer including factors such as when persuasive evidence of an arrangement exits, delivery has occurred, the sales price is fixed and determinable, and collection is probable. Revenue consists of the invoice value for the sale of goods and services net of value-added tax (“VAT”), rebates and discounts and returns. The Company nets sales return in gross revenue, i.e., the revenue shown in the income statement is the net sales.

  

e. FOREIGN CURRENCY TRANSLATION

 

The Company maintains its books and accounting records in Renminbi (“RMB”), the currency of the PRC, The Company’s functional currency is also RMB. The Company has adopted FASB ASC 830-30 in translating financial statement amounts from RMB to the Company’s reporting currency, United States dollars (“US$”). All assets and liabilities are translated at the current rate. The shareholders’ equity accounts are translated at appropriate historical rate. Revenue and expenses are translated at the weighted average rates in effect on the transaction dates.

  

Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are include in the results of operations as incurred.

 

6
 

 

f. RECLASSIFICATIONS

 

       Certain items previously reported under specific financial statement captions have been reclassified to conform to the current year presentation.

 

NOTE C- RECENTLY ISSUED FINANCIAL STANDARDS

 

In October 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (ASU) 2012-04, “Technical Corrections and Improvements” in Accounting Standards Update No. 2012-04. The amendments in this update cover a wide range of Topics in the Accounting Standards Codification. These amendments include technical corrections and improvements to the Accounting Standards Codification and conforming amendments related to fair value measurements. The amendments in this update will be effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2012-04 did not have a material impact on the Company’s financial position or results of operations.

 

In August 2012, FASB issued ASU 2012-03, “Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (SAB) No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22 (SEC Update)” in Accounting standards Update No. 2012-03. This update amends various SEC paragraphs pursuant to the issuance of SAB No. 114. The adoption of ASU 2012-03 is not expected to have a material impact on the Company’s financial position or results of operations.

 

In July 2012, FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” in Accounting Standards Update No. 2012-02. This update amends ASU 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment and permits an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30, Intangibles - Goodwill and Other - General Intangibles Other than Goodwill. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The adoption of ASU 2012-02 did not have a material impact on the Company’s financial position or results of operations.

 

In December 2011, FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers the requirement within ASU 2011-05 to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. During the deferral, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the issuance of ASU 2011-05. These ASUs are required to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. As these accounting standards do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income, the adoption of these standards is not expected to have an impact on our consolidated financial statements.

 

In December 2011, FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (ASU 2011-11). This newly issued accounting standard requires an entity to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on its financial position. This ASU is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. As this accounting standard only requires enhanced disclosure, the adoption of this standard is not expected to have an impact on our consolidated financial statements.

 

7
 

 

 

NOTE D - RELATED PARTY TRANSACTIONS

 

The Company continued to purchase packaging materials from the Ruili Group Co., Ltd. The Ruili Group Co., Ltd., is the minority shareholder of Ruian and is controlled by the Zhang family, who is also the controlling party of the Company. The Company sold certain automotive products to Guangzhou Kormee Vehicle brake technology development Co., Ltd., which is controlled by the Ruili Group Co., Ltd. MGR holds a 30% interest in SIH. The stockholders of MGR were the management of SIH.

 

The following related party transactions are reported for the three months ended March 31, 2013 and March 31, 2012:

 

   Three Months Ended March 31, 
   2013   2012 
PURCHASES FROM:          
Ruili Group Co., Ltd.  $885,181   $1,065,227 
Total purchases  $885,181    1,065,227 
           
SALES TO:          
Ruili Group Co., Ltd.  $238,181   $586,789 
Total sales  $238,181   $586,789 

 

   March 31,   December 31, 
   2013   2012 
Prepayments        

Ruili Group Co., Ltd.

  $182,948   $ 
Total  $182,948   $ 
           
ACCOUNTS PAYABLE          
Ruili Group Co., Ltd.  $   $94,954 
Total  $   $94,954 
           
OTHER PAYABLES          
MGR Hong Kong Limited  $69,733   $25,559 
Ruili Group Co., Ltd.  $70,230   $7,524 
Total  $139,963   $33,083 

  

NOTE E - ACCOUNTS RECEIVABLE

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the three months ended March 31, 2013. The changes in the allowance for doubtful accounts at March 31, 2013 and December 31, 2012 are summarized as follows:

 

8
 

 

   March 31, 2013   December 31, 2012 
Beginning balance  $998,492   $892,455 
Add: Increase to allowance   236,765    106,037 
Less: Accounts written off        
           
Ending balance  $1,235,257   $998,492 

 

   March 31,   December 31, 
   2013   2012 
Accounts receivable  $59,762,146   $63,152,001 
Less: allowance for doubtful accounts   (1,235,257)   (998,492)
           
Account receivable balance, net  $58,526,889   $62,153,509 

 

NOTE F - INVENTORIES

 

At March 31, 2013 and December 31, 2012, inventories consisted of the following:

 

   March 31, 2013   December 31, 2012 
Raw materials  $10,880,153   $9,116,931 
Work in process   16,356,117    20,552,486 
Finished goods   34,478,439    27,106,408 
Total Inventories  $61,714,709   $56,775,825 

  

NOTE G - PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following, at March 31, 2013 and December 31, 2012:

 

   March 31, 2013   December 31, 2012 
Machinery  $43,411,366   $52,212,579 
Molds   1,404,033    1,384,781 
Office equipment   1,842,972    1,637,402 
Vehicles   2,067,400    2,025,702 
Buildings   9,012,013    8,888,441 
Machinery held under capital lease   28,720,360    18,165,511 
           
Sub-Total   86,458,144    84,314,416 
           
Less: Accumulated depreciation   (39,585,533)   (37,351,817)
           
Property, plant and equipment, net  $46,872,611   $46,962,599 

 

9
 

 

Depreciation expense charged to operations was $1,702,915 and $1,821,309 for the three months ended March 31, 2013 and March 31, 2012, respectively.

 

NOTE H- LEASEHOLD IMPROVEMENTS

 

   March 31,   December 31, 
   2013   2012 
Cost:  $568,329   $550,702 
Less: Accumulated amortization:   (236,915)   (214,988)
Leasehold improvements, net  $331,414   $335,714 

 

By law and practice, when improvements are made to real property and those improvements are permanently affixed to the property, the title to those improvements automatically transfers to the owner of the property. The lessee’s interest in the improvements is not a direct ownership interest but rather it is an intangible right to use and benefit from the improvements during the term of the lease. The leasehold improvements are amortized over the lease term.

 

In May 2009, Ruian entered into a lease agreement with Ruili Group Co., Ltd. for the lease of a manufacturing plant. This manufacturing plant was not part of the assets acquired from Ruili Group Co., Ltd. The lease term is from September 2009 to May 2017.

 

In August 2009, SIH entered into a lease agreement with MGR for the lease of an office with a five-year lease term.

  

In August 2010, a new a lease agreement was signed between Ruian and Ruili Group Co., Ltd., under which Ruian leased 32,410 square meters manufacturing plant for its new purchased passenger vehicles brake systems business. The lease term is from September 2009 to August 2020.

 

NOTE I- LAND USE RIGHTS

 

   March 31,   December 31, 
   2013   2012 
Cost:  $16,908,792   $16,676,941 
Less: Accumulated amortization:   (2,055,212)   (1,934,894)
Land use rights, net  $14,853,580   $14,742,047 

 

10
 

 

According to the law of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. The Company purchased the land use rights from Ruili Group for approximately $13.9 million on September 28, 2007. The company has been negotiating with the government for a reduction in or exemption from the tax being sought by the government in connection with the transfer of the land use rights, and pending resolution of that issue, we have deferred accrual or payment of the tax. Due to the lack of resolution of that issue, the land use right certificate has not been issued to the Company. We plan to conclude negotiations with the government and to obtain the land use rights certificate as soon as practicable. Amortization expenses were $92,774 and $85,538 for the three months ended March 31, 2013 and 2012, respectively.

 

NOTE J - INTANGIBLE ASSETS

 

Intangible assets owned by the Company included patent technology and management software licenses. Amortization expenses were $4,244 and $4,188 for the three months ended March 31, 2013 and 2012, respectively. Future estimated amortization expense is as follows:

 

2013   2014   2015   2016   2017   Thereafter 
$12,528   $13,574   $11,990   $11,990   $9,128   $3,465 

  

NOTE K - PREPAYMENTS

 

Prepayments consisted of the following as of March 31, 2013 and December 31, 2012:

 

   March 31,
2013
   December 31,
2012
 
Raw material suppliers  $4,874,506   $4,659,154 
Equipment purchases   1,058,843    1,063,589 
           
Total prepayments  $5,933,349   $5,722,743 

  

NOTE L - DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES

 

Deferred tax assets consisted of the following as of March 31, 2013 and December 31, 2012 comprise the following:

 

   March 31, 2013   December 31, 2012 
Deferred tax assets - current          
Provision   192,284    156,673 
Warranty   595,853    568,161 
Deferred tax assets   788,137    724,834 
Valuation allowance        
Net deferred tax assets - current   788,137    724,834 
           
Deferred tax liabilities - current          
Revenue (net off cost)   63,545    37,202 
Deferred tax liabilities - current          
           
Net deferred tax assets - current   724,593    687,632 
           
Deferred tax liabilities - non-current          
Land use right   310,153    291,995 
Deferred tax liabilities - non-current   310,153    291,995 

 

11
 

 

Deferred taxation is calculated under the liability method in respect of taxation effect arising from all timing differences, which are expected with reasonable probability to realize in the foreseeable future. The Company and its subsidiaries do not have income tax liabilities in U.S. as the Company had no United States taxable income for the reporting period. The Company’s subsidiary registered in the PRC is subject to income taxes within the PRC at the applicable tax rate.

 

NOTE M ACCEPTANCE NOTES TO VENDORS

 

Bank acceptance notes to vendors represent accounts payable in the form of bills of exchange whose acceptances are guaranteed and settlements are handled by banks. From time to time we receive bank acceptance notes payable to the Company from our customers, for goods we sell to those customers. If the notes are not yet due and payable, we may exchange them at a bank in exchange for notes payable to our suppliers, and deliver those notes to our vendors. In such cases, we pay a small service fee to the banks. The bank acceptance notes usually mature and are payable to vendors by the banks in six months. The Company does not have to pay any interest to the banks on these notes. The vendors would pay interest if they discounted the bank acceptance notes to vendors at the banks.

 

Bank acceptance notes to vendors were both $0 as of each of March 31, 2013 and December 31, 2012.

 

NOTE N – SHORT-TERM BANK LOANS

 

Bank loans represented the following as of each of March 31, 2013 and December 31, 2012:

 

   March 31,
2013
   December 31,
2012
 
Secured  $11,044,709   $14,599,753 

 

The Company obtained those short term loans from Bank of China and Agricultural Bank of China, respectively, to finance general working capital as well as new equipment acquisition. The Company did not provide any guarantee to any other parties. Interest rate for the loans ranged from1.37% to 6.16% per annum. The maturity dates of the loans ranged from June 17, 2013 to July 27, 2013. 

 

Corporate or personal guarantee:

 

$2.8 Million Guaranteed by Ruili Group Co., Ltd., a related party;
$8.3 Million Guaranteed by Ruili Group Co., Ltd., a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both principal shareholders.

 

12
 

 

NOTE O - ACCRUED EXPENSES

 

Accrued expenses consisted of the following as of March 31, 2013 and December 31, 2012:

 

   March 31,   December 31, 
   2013   2012 
Accrued payroll  $1,366,738   $1,484,082 
Accrued warranty expenses   3,972,357    3,787,738 
Other accrued expenses   3,778,290    3,229,999 
Total accrued expenses  $9,117,385   $8,501,819 

 

NOTE P –CAPITAL LEASE OBLIGATIONS

 

   March 31,   December 31, 
   2013   2012 
           
Total Capital Lease Obligations  $13,792,184   $10,458,352 
           
Less: Current portion  $(3,662,006)  $(10,458,352)
Non-current portion  $10,130,178   $ 

 

The 2012 capital lease obligation was under an agreement with International Far Eastern Leasing Co., Ltd., for a term of 60 months and an interest rate of 7.95% per annum, payable monthly in arrears. International Far Eastern Leasing Co., Ltd. is the subsidiary of China Sinochem Corporation. To reduce the financing expense, the Company entered into a new leasing agreement with International Far Eastern Leasing Co., Ltd. after communication with it in December 2012 and terminated the original agreement. The duration of the new agreement is forty eight (48) months. The value of the leased equipment is RMB91, 428,571, with a security deposit of RMB11, 428,571. The actual amount is RMB80,000,000. The Company prepaid all interests of RMB10, 705,357 after the discount and has the lease payment of RMB1, 904,761.90 monthly. The prepaid capital lease interest will be amortized over the life of capital lease agreement using the effective interest method.

 

NOTE Q – RESERVE

 

The reserve funds are comprised of the following:

 

   March 31,   December 31, 
   2013   2012 
Statutory surplus reserve fund  $9,806,289   $9,676,183 
Total  $9,806,289   $9,676,183 

 

Pursuant to the relevant laws and regulations of Sino-foreign joint venture enterprises, the profits of the Company's subsidiaries, which are based on their PRC statutory financial statements, are available for distribution in the form of cash dividends after they have satisfied all the PRC tax liabilities, provided for losses in previous years, and made appropriations to reserve funds, as determined at the discretion of the board of directors in accordance with PRC accounting standards and regulations.

 

13
 

 

As stipulated by the relevant laws and regulations for enterprises operating in the PRC, Ruian is required to make annual appropriations to the statutory surplus funds. In accordance with the relevant PRC regulations and the articles of association of the respective companies, Ruian is required to allocate a certain percentage of its profits after taxation, as determined in accordance with PRC accounting standards applicable to the Company, to the statutory surplus reserve until such reserve reaches 50% of the registered capital of the Company.

 

Net income as reported in the US GAAP financial statements differs from that as reported in the PRC statutory financial statements. In accordance with the relevant laws and regulations in the PRC, the profits available for distribution are based on the statutory financial statements. If Ruian has foreign currency available after meeting its operational needs, Ruian may make its profit distributions in foreign currency to the extent foreign currency is available. Otherwise, it is necessary to obtain approval and convert such distributions at an authorized bank. The reserve fund consists of retained earnings which have been allocated to the statutory reserve fund.

 

NOTE R - INCOME TAXES

 

The Joint Venture is registered in the PRC, and is therefore subject to state and local income taxes within the PRC at the applicable tax rate on the taxable income as reported in the PRC statutory financial statements in accordance with relevant income tax laws.

 

Company increased its investment in the Joint Venture as a result of its financing in December, 2006. In accordance with the Income Tax Law of the People's Republic of China on Foreign-invested Enterprises and Foreign Enterprises, the Joint Venture is eligible for additional preferential tax treatment. For the years 2007 and 2008, the Joint Venture entitled to an income tax exemption on all pre-tax income generated by the company above its pre-tax income generated in the year 2006. Thereafter, the Joint Venture will enjoy a 50% exemption from the effective income tax rate on any pre-tax income above its 2006 pre-tax income, to be recognized in the years 2009, 2010 and 2011. The above taxation exemption was superseded, because the Joint Venture has been awarded the Chinese government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate of 15% for years 2009 through 2011. In 2012 December, the Joint Venture passed the re-assessment by the government, based on PRC income tax laws. As a result, the tax rate was 25% for the first three quarters of 2012. Accordingly, it was taxed, and will be taxed at the 15% tax rate in 2013 and 2014.

 

The reconciliation of the effective income tax rate of Ruian to the statutory income tax rate in the PRC for the first quarter of 2013 and 2012 is as follows:

 

   Three months ended
March 31, 2013
   Three months
ended March 31,
2012
 
         
US Statutory income tax rate   35.00%   35.00%
           
Valuation allowance recognized with respect to the loss in the US company   -35.00%   -35.00%
           
HK Statutory income tax rate   16.50%   16.50%
           
Valuation allowance recognized with respect to the loss in those HK company   -16.50%   -16.50%
           
China Statutory income tax rate   25.00%   25.00%
           
China Statutory income exemption   -10.00%   0.00%
           
Tax refund        
Other items   -4.05%   3.17%
           
Effective tax rate   10.95%   28.17%

 

14
 

 

   Three months
ended March 31,
2013
   Three months ended
March 31, 2012
 
Computed income tax provision at the statutory rate  $408,489   $902,117 
Tax exemption   (241,196)    
Tax refund        
Deferred tax provision   (13,212)   (68,104)
           
Current period permanent differences and other reconciling items   14,773    184,643 
Total income taxes  $168,854   $1,018,656 

 

Income taxes are calculated on a separate entity basis. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s net deferred tax assets and liabilities are approximately as mentioned above at March 31, 2013. There currently is no tax benefit recorded for the United States. The tax authority may examine the tax returns of the Company three years after the year ended. In the three months ended March 31, 2013, there were no penalties and interest, which generally are recorded in the general and administrative expenses or in the tax expenses. The provisions for income taxes for the three months ended March 31, 2013 and 2012, respectively, are summarized as follows:

 

   Three months
ended March 31,
2013
   Three months ended
March 31, 2012
 
         
Current  $182,065   $1,086,760 
Deferred   (13,212)   (68,104)
           
Total  $168,854   $1,018,656 

 

As of March 31, 2013 and December 31, 2012, the Company has no unrecognized tax benefits.

 

NOTE S - Non-controlling interest in subsidiaries

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest, owned by Ruili Group Co., Ltd., in Ruian, and a 40% non-controlling interest, owned by the Company’s Joint Venture partners, in SIH. Net income attributable to non-controlling interests in subsidiaries amounted to $140,300 and $263,889 for the three months ended March 31, 2013 and 2012, respectively.

 

15
 

 

   March 31, 2013   March 31, 2012 
           
10% non-controlling interest in Ruian  $144,562   $258,946 
           
40% non-controlling interest in SIH  $(4,262)  $4,943 
           
Total  $140,300   $263,889 

 

NOTE T – OPERATING LEASES

 

In December 2006, Ruian entered into a lease agreement with Ruili Group Co., Ltd. for the lease of two apartment buildings. These two apartment buildings are for Ruian’s management personnel and staff, respectively. The lease term is from January 2007 to December 2011 for one of the apartment buildings and from January 2007 to December 2012 for the other. In December 2011, a new lease agreement was signed for the lease of two apartment buildings. The lease term is from January 2012 to December 2016.

 

In May 2009, Ruian entered into a lease agreement with Ruili Group Co., Ltd. for the lease of a manufacturing plant. The lease term is from September 2009 to May 2017.

 

In August 2009, SIH entered into a lease agreement with MGR for the lease of an office with a five-year lease term. The leasehold improvements are amortized over the lease term.

 

In August 2010, a new a lease agreement was signed between Ruian and Ruili Group Co., Ltd., under which Ruian leased 32,410 square meters manufacturing plant for its new purchased passenger vehicles brake systems business. The lease term is from September 2009 to August 2020.

 

The lease expenses were $451,948 and $313,838 for the three months ended March 31, 2013 and March 31, 2012, respectively.

 

Future minimum rental payments for the years ending on December 31 are as follows:

 

   2013   2014   2015   2016   Thereafter 
                          
Operating Lease Commitments  $1,365,268   $1,820,358   $1,820,358   $1,820,358   $10,922,145 

 

NOTE U - ADVERTISING COSTS

 

Advertising costs were $30,827 and $29,725 for the three months ended March 31, 2013 and March 31, 2012, respectively.

 

NOTE V- RESEARCH AND DEVELOPMENT EXPENSE

 

Research and development costs are expensed as incurred and were $1,390,464 and $1,267,156 for the three months ended March 31, 2013 and March 31, 2012, respectively.

 

16
 

 

NOTE W - WARRANTY CLAIMS

 

Warranty claims were $430,533 and $461,538 for the three months ended March 31, 2013 and March 31, 2012, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The movement of accrued warranty expenses for the three months ended March 31, 2013 was as follows:

Beginning balance at January 01, 2013  $3,787,738 
Aggregate reduction for payments made   430,533 
Aggregate increase for new warranties issued during current period   245,914 
Effect on changes in foreign exchange rate    
Ending balance at March 31, 2013:  $3,972,357 

 

NOTE X – SEGMENT INFORMATION

 

The Company produces brake systems and other related components (“commercial vehicles brake systems, etc.”) for different types of commercial vehicles. On August 31, 2010, the Company through Ruian, executed an Asset Purchase Agreement to acquire, and purchased, a segment of the passenger vehicle auto parts business (passenger vehicles brake systems) of Ruili Group Co., Ltd. As a result of this acquisition, the Company's product offerings were expanded to both commercial and passenger vehicles' brake systems and other key safety-related auto parts.

 

The Company has two operating segments: commercial vehicles brake systems, etc. and passenger vehicles brake systems, etc.

 

All of the Company’s long-lived assets are located in the PRC and Hong Kong. The Company and its subsidiaries did not have long-lived assets in the United States for the reporting periods.

 

   Three Months Ended March 31, 
   2013   2012 
         
NET SALES TO EXTERNAL CUSTOMERS          
Commercial vehicles brake systems  $34,002,216   $35,467,955 
Passenger vehicles brake systems   7,315,944    9,130,286 
           
Net sales  $41,318,160   $44,598,241 
INTERSEGMENT SALES          
Commercial vehicles brake systems  $   $ 
Passenger vehicles brake systems        
           
Intersegment sales  $   $ 
GROSS PROFIT          
Commercial vehicles brake systems  $8,438,728   $10,165,832 
Passenger vehicles brake systems   

2,738,153

    2,050,465 
All other          
Gross profit  $11,176,881   $12,216,297 
Selling and distribution expenses   3,361,557    3,170,902 
General and administrative expenses   4,163,146    3,857,757 
Research and development expenses   1,390,464    1,267,156 
Financial Expenses   946,244    594,897 
Income (loss) from operations   1,315,470    3,325,585 
Other income (expense), net   227,063    290,949 
Income (loss) before income tax expense (benefit)  $1,542,533   $3,616,534 
CAPITAL EXPENDITURE          
Commercial vehicles brake systems  $794,830   $314,476 
Passenger vehicles brake systems   171,016    80,954 
           
Total  $965,846   $395,430 
DEPRECIATION AND AMORTIZATION          
Commercial vehicles brake systems  $1,639,573   $1,542,513 
Passenger vehicles brake systems   352,772    397,079 
           
Total  $1,992,345   $1,939,592 

 

17
 

 

   March 31, 2013   December 31,
2012
 
         
TOTAL ASSETS          
Commercial vehicles brake systems  $201,818,122   $192,842,721 
Passenger vehicles brake systems   43,423,349    50,718,264 
           
Total  $245,241,471   $243,560,985 

 

   March 31, 2013   December 31,
2012
 
         
LONG LIVED ASSETS          
Commercial vehicles brake systems  $53,213,108   $50,662,641 
Passenger vehicles brake systems   11,449,375    13,324,439 
           
Total  $64,662,483   $63,987,080 

 

All of the Company’s long-lived assets are located in the PRC and Hong Kong. The Company and its subsidiaries do not have long-lived assets in the United States for the reporting periods.

 

NOTE Y – PURCHASE DISCOUNT

 

Purchase discounts represent discounts received from vendors for purchasing raw materials. The Company did not receive any purchase discounts during the three months ended March 31, 2013 and March 31, 2012.

 

18
 

 

NOTE Z – SHIPPING AND HANDLING COSTS

 

Shipping and handling costs incurred by the Company are included in selling expenses in the accompanying consolidated statements of income. Shipping and handling costs were $731,435 and $1,115,315 for the three month ended March 31, 2013 and March 31, 2012, respectively.

 

NOTE AA – STOCK COMPENSATION PLAN

 

We had no stock-based compensation expense during the three months ended March 31, 2013 and March 31, 2012, respectively. There were no employee stock options or warrants outstanding as of March 31, 2013.

 

NOTE AB- COMMITMENTS AND CONTINGENCIES

 

(1)  According to the law of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. The Company purchased the land use rights from Ruili Group for approximately $13.9 million on September 28, 2007. The Company has not yet obtained the land use right certificate.

 

(2)  Information regarding lease commitments is provided in Note T.

 

NOTE AC - OFF-BALANCE SHEET ARRANGEMENTS

 

At March 31, 2013, we did not have any material commitments for capital expenditures or have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following is management’s discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying unaudited condensed consolidated financial statements, as well as information relating to the plans of our current management. This quarterly report on Form 10-Q includes forward-looking statements. Any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Generally, the words “believes,” “anticipates,” “may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar expressions, or the negative thereof, or comparable terminology, are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including the matters set forth in this report or other reports or documents we file with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those anticipated. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to update these forward-looking statements.

 

The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-Q.

 

OVERVIEW

 

The Company manufactures and distributes automotive brake systems and other key safety-related components to automotive original equipment manufacturers, or OEMs, and the related aftermarket both in China and internationally for use primarily in different types of commercial vehicles, such as trucks and buses, and in passenger vehicles. Management believes that it is the largest manufacturer of automotive brake systems in China for commercial vehicles such as trucks and buses.

 

19
 

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

For a summary of our accounting policies and estimates, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the Year ended December 31, 2012.

 

See Note P to the attached Unaudited Condensed Consolidated Financial Statements for the information regarding changes in taxation by the government of China.

 

Results of Operations

 

Results of operations for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012.

 

SALES

 

   Three Months ended   Three Months ended 
   March 31, 2013   March 31, 2012 
   (U.S.  dollars in
millions)
 
Commercial vehicle brake systems, etc.  $34.0    82.3%  $35.5    79.6%
Passenger vehicle brake systems, etc.  $7.3    17.7%  $9.1    20.4%
                     
Total  $41.3    100%  $44.6    100%

 

Sales were $41,318,160 and $44,598,241 for the three months ended March 31, 2013 and 2012, respectively, a decrease of $3.3 million or 7.4%. The decrease was mainly due to the decreased sales to the China OEM and aftermarkets.

 

The sales from commercial vehicle brake systems decreased by $1.5 million, or 4.2%, to $34.0 million for the first quarter of 2013, compared to $35.5 million for the same period of 2012. Due to the slowdown of the commercial vehicle market in the first quarter of 2013, the sales from the OEM market decreased, which impacted the sales of the commercial vehicle brake systems.

 

Due to the slowdown of the passenger vehicle market and the customer base adjustment made by management, the sales from passenger vehicle brake systems decreased by $1.8 million or 19.8%, to $7.3 million for the first quarter of 2013, compared to $9.1 million for the same period of 2012.

 

A breakdown of net sales revenue for these markets for the first quarter of the 2013 and 2012, respectively, is set forth below:

 

   Three
Months
       Three
Months
         
   ended   Percent   ended   Percent     
   March 31,
2013
   of
Total Sales
   March 31,
2012
   of
Total Sales
   Percentage
Change
 
       (U.S. dollars in million)         
China OEM market  $22.8    55.2%  $25.8    57.8%   -11.6%
China Aftermarket  $9.2    22.3%  $9.8    22.0%   -6.1%
International market  $9.3    22.5%  $9.0    20.2%   3.3%
Total  $41.3    100.0%  $44.6    100.0%   -7.4%

 

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Despite the overall growth of the output and sales of all the automobiles in China, in the first quarter of 2013, the commercial vehicle production and sales was 1.014 million units and 1.001 million units, up 0.08% and down 1.72%, respectively, and the production of heavy duty truck decreased by 10.87% compared to the first quarter of 2012. The decline of the overall sales of heavy-duty trucks in China in the first quarter of 2013 could be attributed to the deceleration of the growth in capital investment, domestic consumption and international trade, which resulted in the reduced demand for heavy-duty trucks in the construction of residential and commercial real estate development projects, infrastructure projects, as well as highway transportation of goods.

 

SORL has begun making sales for construction equipment and expanded its market share in the bus market, which partially offset the effects of these declines. Our first-quarter OEM sales declined 11.6% from 2012’s first quarter, to $22.8 million.

 

Our sales to the Chinese aftermarket decreased by $0.6 million or 6.1%, to $9.2 million for the first quarter of 2013, compared to $9.8 million for the same period of 2012. The usage of heavy-duty trucks in the construction of real estate development projects and infrastructure projects was reduced in China in the first quarter of 2013, which resulted in the reduced replacement of auto parts. We will continue with our strategies to further optimize our sales network, to help further penetrate into new markets. Accelerated urbanization and the Chinese government’s increased support for public transportation favor expansion in the bus aftermarket, which may present an opportunity for us to increase our sales in that market

 

Our export sales increased by $0.3 million or 3.3%, to $9.3 million for the first quarter of 2013, as compared to $9.0 million for the same period of 2012. A part of our strategy is to strengthen and expand our distribution networks to increase the awareness of our brand overseas. The increase primarily resulted from the recovery of the global economy.

 

COST OF SALES AND GROSS PROFIT

 

Cost of sales for the three months ended March 31, 2013 were $30,141,279, a decrease of $2.2 million, or 6.9% from $32,381,944 for the same period last year. Since the decrease of our sales is larger than the decrease of our cost of sales, our gross profit decreased by 8.5% from $12,216,297 for the first quarter of 2012 to $11,176,881 for the first quarter of 2013.

 

Gross margin decreased to 27.1% from 27.4% for the three months ended March 31, 2013 from the same period in 2012. Gross margin is being affected by rising labor expenses, the appreciation of the Chinese currency, and higher raw material prices. We intend to focus in 2013 on increasing production efficiency, improving the technologies of products, and improving our product portfolio, to help us to maintain or increase our gross profit margin.

 

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Cost of sales from commercial vehicle brake systems for the three months ended March 31, 2013 were $25.6 million, a decrease of $0.3 million, or 1.0% from $25.3 million for the same period last year. The gross profit from commercial vehicle brake systems decreased by 17.0% from $10.2 million for the first quarter of 2012 to $8.4 million for the first quarter of 2013. Gross margin from commercial vehicle brake systems decreased to 24.8% from 28.7% for the three months ended March 31, 2013 compared with 2012. Gross margin was affected by rising labor expenses, the appreciation of the Chinese currency, and higher raw material prices.

 

Cost of sales from passenger vehicle brake systems for the three months ended March 31, 2013 were $4.6 million, a decrease of $2.5 million, or 35.3%, from $7.1 million for the same period last year. The gross profit from passenger vehicle brake systems decreased by 33.5% from $2.7 million for the first quarter of 2012 to $2.1 million for the first quarter of 2013. Gross margin from passenger vehicle brake systems increased to 37.4% from 22.5% for the three months ended March 31, 2013 compared with 2012. We intend to focus in 2013 on increasing production efficiency, improving the technologies of products, and improving our product portfolio, to help us to maintain or increase our gross profit margins.

 

SELLING AND DISTRIBUTION EXPENSES

 

Selling and distribution expenses were $3,361,557 for the three months ended March 31, 2013, as compared to $3,170,902 for the same period of 2012, an increase of $190,655 or 6.0%.

 

The increase was mainly due to increased wages expense and packaging expenses. As a percentage of sales revenue, selling expenses increased to 8.1% for the three months ended March 31, 2013, as compared to 7.1% for the same period in 2012.

 

GENERAL AND ADMINISTRATIVE EXPENSES

 

General and administrative expenses were $4,163,146 for the three months ended March 31, 2013, as compared to $3,857,757 for the same period of 2012, an increase of $305,389 or 7.9%. The increase was mainly due to increases in labor expenses and other administrative expenses for marketing of the business. Since our sales decreased but general and administrative expenses increased, as a percentage of sales revenue, general and administrative expenses increased to 10.1% for the three months ended March 31, 2013, as compared to 8.7% for the same period in 2012.

 

RESEARCH AND DEVELOPMENT EXPENSE

 

Research and development expenses include payroll, employee benefits, and other personnel-related expenses associated with product development. Research and development expenses also include first-party development costs. For the three months ended March 31, 2013, research and development expense was $1,390,464, as compared to $1,267,156 for the same period of 2012, an increase of $123,308.

 

DEPRECIATION AND AMORTIZATION

 

Depreciation and amortization expense increased to $1,992,345 for the three months ended March 31, 2013, compared with $1,939,592 for the same period of 2012, an increase of $52,753. The increase in depreciation and amortization expense was primarily due to the increase of purchased production equipment.

 

FINANCIAL EXPENSES

 

Financial expense mainly consists of interest expense, the financing expense associated with our capital lease transaction and currency exchange loss. The financial expense for the three months ended March 31, 2013 increased by $351,347 to $946,244 from $594,897 for the same period of 2012, which was mainly due to increased interest expense and currency exchange loss.

 

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OTHER INCOME

 

Other income, primarily consisting of income from the sales of scraps, was $295,140 for the three months ended March 31, 2013, as compared to $351,845 for the three months ended March 31, 2012, a decrease of $56,705. The decrease was mainly due to a decrease in sales of raw material scraps for the three months ended March 31, 2013.

 

INCOME TAX

 

The Joint Venture is registered in the PRC, and is therefore subject to state and local income taxes within the PRC at the applicable tax rate on the taxable income as reported in the PRC statutory financial The Joint Venture is registered in the PRC, and is therefore subject to state and local income taxes within the PRC at the applicable tax rate on taxable income as reported in the PRC statutory financial statements in accordance with relevant income tax laws.

 

The Company increased its investment in the Joint Venture as a result of its financing in December, 2006. In accordance with the Income Tax Law of the People's Republic of China on Foreign-invested Enterprises and Foreign Enterprises, the Joint Venture was eligible for additional preferential tax treatment for the years 2007 and 2008. In those years, the Joint Venture was entitled to an income tax exemption on all pre-tax income generated by the Company above its pre-tax income generated in the year 2006. This tax exemption was superseded as a result of the Joint Venture having been awarded the Chinese government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate for years 2009 through 2011. In 2012 December, the Joint Venture passed the re-assessment by the government, based on PRC income tax laws. So the tax rate was 25% for the first three quarters of 2012. Accordingly, it continues to be, or will be, taxed at the 15% tax rate in 2013 and 2014.

 

Income tax expense was $168,854, or an 11.0% effective tax rate, for the three months ended March 31, 2013, as compared to $1,018,656, or a 28.2% effective tax rate, for the three months ended March 31, 2012. The main reason was because the tax rate for the first quarter of 2012 was 25%, and it was 15% for the first quarter of 2013 due to renewal of the "High-Tech Enterprise" not received until 2012 December.

 

NET INCOME ATTRIBUTABLE TO NON-CONTROLLING INTEREST IN SUBSIDIARIES

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH, in each case held by our Joint Venture partners. Net income attributable to non-controlling interest in subsidiaries amounted to $140,300 and $263,889 for the three months ended March 31, 2013 and 2012, respectively.

 

NET INCOME ATTRIBUTABLE TO STOCKHOLDERS

 

The net income attributable to stockholders for the three months ended March 31, 2013 decreased by $1.1 million, to $1,233,379 from $2,333,989 for the three months ended March 31, 2012 due to the factors discussed above. Earnings per share (“EPS”), both basic and diluted, for the three months ended March 31, 2013 and 2012, were $0.06 and $0.12 per share, respectively.

 

FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

OPERATING At March 31, 2013, the Company had cash and cash equivalents of $43,222,310, as compared to cash and cash equivalents of $41,253,353 at December 31, 2012. The Company had working capital of $138,282,570 at March 31, 2013, as compared to working capital of $123,953,956 at December 31, 2012, reflecting current ratios of 4.27 and 3.26:1, respectively.

 

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Net cash generated from operating activities was $2,871,322 for three months ended March 31, 2013 compared with $4,319,504 of net cash generated from operating activities in the same period in 2012, a decrease of $1.4 million, primarily due to the increased cash outflow resulted from the changes in bank acceptance notes from customers and inventories.

 

INVESTING - During the three months ended March 31, 2013, the Company expended net cash of $965,846 in investing activities, mainly for acquisition of new equipment. For the three months ended March 31, 2012, the Company utilized $395,430 in investing activities.

 

FINANCING - During the three months ended March 31, 2013, the Company repaid bank loans and a capital lease in the aggregate amount of $499,107. The cash used by financing activities was $5,320,769 for three months ended March 31, 2012.

 

The Company has taken a number of steps to improve the management of its cash flow. We place more emphasis on collection of accounts receivable from our customers. We maintain good relationships with local banks. We believe that our current cash and cash equivalents and anticipated cash flow generated from operations and our bank lines of credit will be sufficient to finance our working capital requirements for the foreseeable future.

 

CURRENCY RISK AND FINANCIAL INSTRUMENTS - Although our reporting currency is U.S. dollar, the functional currency of Joint Venture is RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our Renminbi revenues, earnings and assets, as expressed in our U.S. dollar, will decline. In recent years, the RMB has been appreciating against the U.S. dollar.

 

 Assets and liabilities of our operating subsidiaries are translated into U.S. dollars at the exchange rate at the balance sheet date. The equity accounts are translated at historical exchange rate and their income and expenses items are translated using the average rate for the period. Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. Oversea contracts are primarily dominated by U.S. dollars. As a result of the RMB’s appreciation in value against U.S. dollars in the three months ended March 31, 2013, the Company’s revenue declined. The Company plan to take measures to manage its exposure to foreign currency exchange rate fluctuations, such as diversifying its customer basis overseas into different currency zones, and stipulating predetermined foreign currency exchange rates for payments to be received under its export sales contracts.

 

As the Company’s current outstanding debt obligations are primarily short-term in nature, with fixed interest rates, the Company does not have any material risk from an increase in market interest rates. However, to the extent that the Company arranges new borrowings in the future, an increase in market interest rate would cause a commensurate increase in the interest expense related to such borrowings.

 

OFF-BALANCE SHEET AGREEMENTS

 

At March 31, 2013 we do not have any material commitments for capital expenditures or have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.

 

According to the law of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. The Company purchased the land use rights from Ruili Group for approximately $13.9 million on September 28, 2007. The company has been negotiating with the government for a reduction in or exemption from the tax being sought by the government in connection with the transfer of the land use rights, and pending resolution of that issue, we have deferred accrual or payment of the tax. Due to the lack of resolution of that issue, the land use right certificate has not been issued to the Company. We plan to conclude negotiations with the government and to obtain the land use rights certificate as soon as practicable.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

See the discussion in Item 2 above, “Liquidity and Capital Resources”.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures:

 

As of the end of the period covered by this report, management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”)). Based upon that evaluation, our principal executive officer and principal financial officer concluded that the disclosure controls and procedures were effective in all material respects to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management to allow their timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting:

 

There were no changes in the Company’s internal control over financial reporting during the three months ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

Not applicable.

 

ITEM 1A. RISK FACTORS.

 

Not applicable.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

Not applicable.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

Not applicable.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

Not applicable.

 

ITEM 6. EXHIBITS

 

31.1   Certification of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
     
31.2   Certification of Principal Accounting Officer pursuant to Rule 13a-14 and Rule 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended.
     
32   Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1)

 

(1)Previously furnished in accordance with Item 601(b) (32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated : May 15, 2013 SORL AUTO PARTS, INC.
   
  By: /s/ Xiao Ping Zhang
  Name: Xiao Ping Zhang
  Title: Chief Executive Officer
   
  By: /s/ Zong Yun Zhou
  Name: Zong Yun Zhou
 

Title: Chief Financial Officer

(Principal Accounting Officer)

 

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