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EX-31.1 - EXHIBIT 31.1 - SORL Auto Parts Incv385646_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended June 30, 2014

 

¨ 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 August 14, 2014 there were 19,304,921 shares of Common Stock outstanding

 

 
 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Quarter Ended June 30, 2014

 

INDEX

 

    Page
     
PART I. FINANCIAL INFORMATION (Unaudited) 3
     
Item 1. Financial Statements: 3
     
  Consolidated Balance Sheets as of June 30, 2014 (Unaudited) and December 31, 2013 3
     
  Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2014 and 2013 (Unaudited) 4
     
  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013 (Unaudited) 5
     
  Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2014 (Unaudited) 6
     
  Notes to the Consolidated Financial Statements (Unaudited) 7
     
Item 2. Management’s Discussion and Analysis or Financial Condition and Results of Operations 18
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
     
Item 4. Controls and Procedures 27
     
PART II. OTHER INFORMATION 27
     
Item 1. Legal Proceedings 27
     
Item 1A. Risk Factors 27
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 28
     
Item 3. Defaults Upon Senior Securities 28
     
Item 4. Mine Safety Disclosures 28
     
Item 5. Other Information 28
     
Item 6. Exhibits 28
     
SIGNATURES 29

 

2
 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2014 and December 31, 2013

 

   June 30, 2014   December 31, 2013 
   (Unaudited)   (Audited) 
Assets          
Current Assets          
Cash and cash equivalents  US$27,020,085   US$28,241,983 
Accounts receivable, net of provision   69,189,724    57,912,384 
Bank acceptance notes from customers   23,641,110    20,186,787 
Inventories   82,450,896    76,364,019 
Prepayments   4,622,474    3,773,750 
Current portion of prepaid capital lease interest   371,777    453,053 
Other current assets   2,302,279    2,537,300 
Deferred tax assets   1,731,372    1,392,955 
Total Current Assets   211,329,717    190,862,231 
Fixed Assets          
Machinery   49,341,407    46,475,961 
Molds   1,418,158    1,388,218 
Office equipments   2,096,657    1,960,476 
Vehicles   2,066,179    2,248,280 
Buildings   9,102,678    8,910,501 
Machinery held under capital lease   29,012,601    28,396,853 
Less: accumulated depreciation   (48,383,297)   (44,175,888)
Property, plant and equipment, net   44,654,383    45,204,401 
Leasehold improvements in progress   227,933    264,612 
           
Land Use Rights, Net   14,531,221    14,409,170 
           
Other Non-Current Assets          
           
Intangible assets   180,104    176,302 
Less: accumulated amortization   (136,511)   (126,031)
Intangible assets, net   43,593    50,271 
Security deposits on lease agreement   1,857,459    1,818,244 
Non-current portion of prepaid capital lease interest   216,238    371,355 
Total Other Non-Current Assets   2,117,290    2,239,870 
Total Assets  US$272,860,544   US$252,980,284 
           
Liabilities and Shareholders' Equity          
Current Liabilities          
Accounts payable, including $3,031,309 and $810,310 due to related parties at June 30, 2014 and December 31, 2013, respectively.  US$13,267,766   US$13,290,282 
Deposit received from customers   13,737,468    13,931,658 
Short term bank loans   11,116,360    4,526,863 
Income tax payable   800,102    494,658 
Accrued expenses   11,928,934    10,066,969 
Current portion of capital lease obligations   3,714,917    3,636,488 
Other current liabilities, including $40,570 and $94,246 due to related parties at June 30, 2014 and December 31, 2013, respectively.   1,242,209    256,430 
Total Current Liabilities   55,807,756    46,203,348 
           
Non-Current Liabilities          
Non-current portion of capital lease obligations   5,572,376    7,272,975 
Total Non-Current Liabilities   5,572,376    7,272,975 
           
Total Liabilities  US$61,380,132   US$53,476,323 
           
Stockholders' Equity          
           
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of June 30, 2014 and December 31, 2013   -    - 
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of June 30, 2014 and December 31, 2013   38,609    38,609 
Additional paid-in capital   42,199,014    42,199,014 
Reserves   11,315,415    10,609,435 
Accumulated other comprehensive income   26,396,341    22,465,720 
Retained earnings   110,740,917    104,544,120 
Total SORL Auto Parts, Inc. Stockholders' Equity   190,690,296    179,856,898 
Noncontrolling Interest In Subsidiaries   20,790,116    19,647,063 
Total Equity   211,480,412    199,503,961 
Total Liabilities and Stockholders' Equity  US$272,860,544   US$252,980,284 

 

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

 

3
 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Income and Comprehensive Income

For The Three Months and Six Months Ended on June 30, 2014 and 2013 (Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2014   2013   2014   2013 
                 
Sales  US$65,723,746   US$57,511,004   US$115,717,035   US$98,829,164 
Include: sales to related parties   1,345,506    1,004,391    1,635,583    1,242,572 
Cost of sales   47,209,861    40,688,905    81,816,214    69,783,242 
                     
Gross profit   18,513,885    16,822,099    33,900,821    29,045,922 
                     
Expenses:                    
Selling and distribution expenses   6,473,111    4,911,344    12,178,605    9,319,843 
General and administrative expenses   4,710,874    5,220,131    9,027,028    9,383,277 
Research and development expenses   2,200,558    1,617,147    3,691,757    3,007,611 
                     
Total operating expenses   13,384,543    11,748,622    24,897,390    21,710,731 
                     
Other operating income   549,130    632,105    925,262    835,892 
                     
Income from operations   5,678,472    5,705,582    9,928,693    8,171,083 
                     
Other income   213,292    -    251,596    91,353 
Financial expenses   (479,058)   (492,094)   (1,138,941)   (1,438,338)
Non-operating expenses   (181,401)   (127,224)   (233,308)   (195,301)
                     
Income before provision for income taxes   5,231,305    5,086,264    8,808,040    6,628,797 
                     
Provision for income taxes   651,210    539,334    1,164,445    708,188 
                     
Net income  US$4,580,095   US$4,546,930   US$7,643,595   US$5,920,609 
                     
Net income attributable to noncontrolling  interest in subsidiaries   447,621    512,138    740,818    652,438 
                     
Net income attributable to common stockholders  US$4,132,474   US$4,034,792   US$6,902,777   US$5,268,171 
                     
Comprehensive income:                    
                     
Net income  US$4,580,095   US$4,546,930   US$7,643,595   US$5,920,609 
                     
Foreign currency translation adjustments   (25,135)   1,150,709    4,332,856    3,810,071 
                     
Comprehensive income   4,554,960    5,697,639    11,976,451    9,730,680 
                     
Comprehensive income attributable to noncontrolling interest in subsidiaries   445,057    628,535    1,143,053    1,031,926 
                     
Comprehensive income attributable to common shareholders  US$4,109,903   US$5,069,104   US$10,833,398   US$8,698,754 
                     
Weighted average common share - basic   19,304,921    19,304,921    19,304,921    19,304,921 
                     
Weighted average common share - diluted   19,304,921    19,304,921    19,304,921    19,304,921 
                     
EPS – basic  US$0.21   US$0.21   US$0.36   US$0.27 
                     
EPS – diluted  US$0.21   US$0.21   US$0.36   US$0.27 

 

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

 

4
 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For The Six Months Ended on June 30, 2014 and 2013 (Unaudited)

 

   Six Months Ended June 30, 
   2014   2013 
         
Cash Flows from Operating Activities          
Net income  US$7,643,595   US$5,920,609 
Adjustments to reconcile net income to net cash          
from operating activities:          
Allowance for doubtful accounts   1,194,754    1,634,203 
Depreciation and amortization   3,732,381    3,625,115 
Deferred income tax   (307,429)   (233,687)
Loss on disposal of fixed assets   28,075    - 
Changes in assets and liabilities:          
Account receivable   (11,133,975)   3,762,142 
Bank acceptance notes from customers   (3,098,660)   (7,323,135)
Other currents assets   325,030    18,266 
Inventories   (4,449,536)   (8,496,818)
Prepayments   (743,265)   1,590,962 
Prepaid capital lease interest   252,772    342,776 
Accounts payable and bank acceptance notes to vendors   (254,762)   (5,092,453)
Income tax payable   296,017    - 
Deposits received from customers   (488,943)   2,737,611 
Other current liabilities and accrued expenses   2,624,773    2,513,792 
Net Cash Flows Provided By (Used In) Operating Activities   (4,379,173)   999,383 
           
Cash Flows from Investing Activities          
Acquisition of property and equipment   (2,061,662)   (2,219,689)
Proceeds of disposal of fixed assets   53,437    - 
Net Cash Flows Used In Investing Activities   (2,008,225)   (2,219,689)
           
Cash Flows from Financing Activities          
Proceeds from bank loans   22,292,424    48,751,425 
Repayment of bank loans   (15,904,045)   (53,812,232)
Repayment of capital lease   (1,847,655)   (10,473,023)
Proceeds from capital lease   -    12,783,841 
           
Net Cash Flows Provided By (Used In) Financing Activities   4,540,724    (2,749,989)
           
Effects on changes in foreign exchange rate   624,776    726,068 
           
Net change in cash and cash equivalents   (1,221,898)   (3,244,227)
           
Cash and Cash Equivalents- Beginning of the Year   28,241,983    41,253,353 
           
Cash and Cash Equivalents - End of the Period  US$27,020,085   US$38,009,126 
           
Supplemental Cash Flow Disclosures:          
Interest paid  US$722,728   US$859,771 
Tax paid  US$1,171,310   US$972,107 

 

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

 

5
 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders' Equity

For The Six Months Ended on June 30, 2014 (Unaudited)

 

           Additional           Accumu. Other             
   Number   Common   Paid-in       Retained   Comprehensive   Shareholders'   Noncontrolling   Total 
   of Share   Stock   Capital   Reserves   Earnings   Income   Equity   Interest   Equity 
Beginning Balance - January 1, 2014   19,304,921   $38,609   $42,199,014   $10,609,435   $104,544,120   $22,465,720   $179,856,898   $19,647,063   $199,503,961 
                                              
Net income   -    -    -    -    6,902,777    -    6,902,777    740,818    7,643,595 
                                              
Foreign currency translation adjustment   -    -    -    -    -    3,930,621    3,930,621    402,235    4,332,856 
                                              
Transfer to reserve   -    -    -    705,980    (705,980)   -    -    -    - 
                                              
Ending Balance - June 30, 2014   19,304,921   $38,609   $42,199,014   $11,315,415   $110,740,917   $26,396,341   $190,690,296   $20,790,116   $211,480,412 

 

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

 

6
 

 

SORL Auto Parts, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2014

(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 Ruili Group Ruian Auto Parts Co., Ltd. (the “Joint Venture” or “Ruian”) 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.

 

 The Joint Venture was formed in the People’s Republic of China (“PRC” or “China”) as a Sino-Foreign joint venture on January 17, 2004, pursuant to the terms of a Joint Venture Agreement between the Ruili Group Co., Ltd. (the “Ruili Group”) and Fairford Holdings Limited (“Fairford”), a wholly owned subsidiary of the Company. The Ruili Group was incorporated in China in 1987 and specialized in the development, production and sale of various kinds of automotive parts. Fairford and the Ruili Group contributed 90% and 10%, respectively, of the paid-in capital of the Joint Venture.

 

On November 11, 2009, the Company entered into a joint venture agreement with MGR Hong Kong Limited (‘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 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 the 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.

 

7
 

 

NOTE B - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

(1)BASIS OF PRESENTATION

 

The 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 consolidated balance sheet information as of December 31, 2013 was derived from the consolidated audited financial statements included in Form 10-K. These consolidated financial statements should be read in conjunction with the annual consolidated audited financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2013, and other reports filed with the Securities and Exchange Commission (“SEC”).

 

The accompanying 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. The transfer is decided by several factors, 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, 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.

 

8
 

 

e. FOREIGN CURRENCY TRANSLATION

 

The Company maintains its books and accounting records in 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 included in the results of operations as incurred.

  

f. RECLASSIFICATIONS

 

Certain prior year amounts have been reclassified to conform to the current period presentation. These reclassifications had no impact on net earnings and financial position.

 

NOTE C- RECENTLY ISSUED FINANCIAL STANDARDS

 

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”. The amendments in the ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. It also addresses sources of confusion and inconsistent application related to financial reporting of discontinued operations guidance in U.S. GAAP. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. In addition, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The amendments in the ASU are effective in the first quarter of 2015 for public organizations with calendar year ends. Early adoption is permitted. The Company does not expect the adoption to have a significant impact on its consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from contracts with Customers (Topic 606)”. This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets. This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. The ASU also supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchanged for those goods or services. The standard is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is currently in the process of evaluating the impact of the adoption on its consolidated financial statements.

 

 

NOTE D - RELATED PARTY TRANSACTIONS

 

The Company continues to purchase packaging materials from the Ruili Group. The Ruili Group is the minority shareholder of Joint Venture and is collectively controlled by Mr. Xiao Ping Zhang, his wife Ms. Shuping Chi, and his brother Mr. Xiao Feng Zhang. In addition, the Company purchases from two other related parties, Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd. (“Guangzhou Kormee”) and Ruian Kormee Vehicle brake Co., Ltd. (“Ruian Kormee”). Guangzhou Kormee is controlled by the Ruili Group and Ruian Kormee is the wholly-owned subsidiary of Guangzhou Kormee. The Company also sells certain automotive products to Guangzhou Kormee, Ruian Kormee and the Ruili Group. MGR holds a 30% interest in SIH. The stockholders of MGR are the management of SIH.

 

9
 

 

The following related party transactions are reported for the three months and six months ended June 30, 2014 and June 30, 2013:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2014   2013   2014   2013 
PURCHASES FROM:                    
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.  $934,065   $816,189   $1,472,020   $816,189 
Ruian Kormee Vehicle Brake Co., Ltd.   420,691    551,457    769,957    551,457 
The Ruili Group   1,109,426    1,161,423    2,043,053    2,046,604 
Total Purchases  $2,464,182   $2,529,069   $4,285,030   $3,414,250 
                     
SALES TO:                    
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.  $934,064   $289,571   $974,711   $289,571 
Ruian Kormee Vehicle Brake Co., Ltd.   30,266        55,739     
The Ruili Group   381,176    714,820    605,133    953,001 
Total Sales  $1,345,506   $1,004,391   $1,635,583   $1,242,572 

 

   June 30,   December 31, 
   2014   2013 
ACCOUNTS PAYABLE          
Ruian Kormee Vehicle brake Co., Ltd.  $180,124   $445,896 
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.   1,621,993     
The Ruili Group   1,229,192    364,414 
Total  $3,031,309   $810,310 
           
OTHER PAYABLES          
MGR Hong Kong Limited  $   $94,246 
The Ruili Group   40,570     
Total  $40,570   $94,246 

 

The Company entered into several lease agreements with related parties, see Note M for more details.

 

In addition, the Company provides guarantees to the loans obtained by Ruili Group from the Bank of Ningbo in the amount of RMB108,000,000 (approximately $17,182,404) for the period from September 26, 2013 to September 25, 2014.

 

10
 

 

NOTE E - ACCOUNTS RECEIVABLE

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the six months ended June 30, 2014. The changes in the allowance for doubtful accounts at June 30, 2014 and December 31, 2013 are summarized as follows:

 

   June 30, 2014   December 31, 2013 
Beginning balance  $3,813,415   $998,492 
Add: Increase to allowance   1,280,165    2,814,923 
Less: Accounts written off        
           
Ending balance  $5,093,580   $3,813,415 

 

   June 30,   December 31, 
   2014   2013 
Accounts receivable  $74,283,304   $61,725,799 
Less: allowance for doubtful accounts   (5,093,580)   (3,813,415)
           
Account receivable balance, net  $69,189,724   $57,912,384 

  

NOTE F - INVENTORIES

 

At June 30, 2014 and December 31, 2013, inventories consisted of the following:

 

   June 30, 2014   December 31, 2013 
Raw Materials  $10,215,642   $12,380,061 
Work in process   30,536,330    31,546,330 
Finished Goods   41,727,633    32,466,337 
Less: Write-down of inventories   (28,709)   (28,709)
Total Inventory  $82,450,896   $76,364,019 

 

11
 

  

NOTE G - PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following, at June 30, 2014 and December 31, 2013:

 

   June 30, 2014   December 31, 2013 
Machinery  $49,341,407   $46,475,961 
Molds   1,418,158    1,388,218 
Office equipment   2,096,657    1,960,476 
Vehicles   2,066,179    2,248,280 
Buildings   9,102,678    8,910,501 
Machinery held under capital lease   29,012,601    28,396,853 
           
Sub-Total   93,037,680    89,380,289 
           
Less: Accumulated depreciation   (48,383,297)   (44,175,888)
           
Property, plant and equipment, net  $44,654,383   $45,204,401 

 

Depreciation expense charged to operations was $3,481,100 and $3,386,360 for the six months ended June 30, 2014 and June 30, 2013, respectively.

 

NOTE H - DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES

 

Deferred tax assets consisted of the following as of June 30, 2014 and December 31, 2013:

 

   June 30, 2014   December 31, 2013 
Deferred tax assets - current          
Allowance for doubtful accounts  $771,102   $578,928 
Revenue (net off cost)   46,860    8,653 
Unpaid accrued expenses   137,318    105,558 
Warranty   776,092    699,816 
Deferred tax assets   1,731,372    1,392,955 
Valuation allowance        
Net deferred tax assets - current  $1,731,372   $1,392,955 

 

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.

 

12
 

 

NOTE I – SHORT-TERM BANK LOANS

 

Bank loans represented the following as of June 30, 2014 and December 31, 2013:

 

   June 30,   December 31, 
   2014   2013 
Secured  $11,116,360   $4,526,863 

  

The Company obtained those short term loans from Bank of China, Construction Bank of China and Agricultural Bank of China, respectively, to finance general working capital as well as new equipment acquisition. Interest rate for the loans ranged from3.53% to 6.44% per annum. The maturity dates of the loans ranged from July 1, 2014 to December 20, 2014.

  

Corporate or personal guarantee:
$10.7 Million   Guaranteed by the Ruili Group, a related party;
$0.4 Million   Guaranteed by the Ruili Group, a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both principal shareholders.

 

NOTE J –CAPITAL LEASE OBLIGATIONS

 

   June 30,   December 31, 
   2014   2013 
         
Total Capital Lease Obligations  $9,287,293   $10,909,463 
Less: Current portion   (3,714,917)   (3,636,488)
Non-current portion  $5,572,376   $7,272,975 

  

On September 13, 2011, the Company entered into a leasing agreement with International Far Eastern Leasing Co., Ltd., a subsidiary of China Sinochem Corporation, for a term of 60 months and an interest rate of 7.95% per annum, payable monthly in arrears. To reduce the financing expense, the Company entered into a new leasing agreement with International Far Eastern Leasing Co., Ltd. in December 2012 and terminated the original agreement. The duration of the new agreement is 48 months with an interest rate of 6.4% per annum and is secured with the Company’s equipment in the original cost of $28,396,853. The capital lease obligation obtained by the Company is RMB 91,428,571 (approximately $14,545,950) and the Company is required to maintain a security deposit of RMB 11,428,571 (approximately $1,818,244). The Company prepaid all interests of RMB 10,705,357 (approximately $1,703,212) after the discount and is obligated for the payment of RMB 1,904,761.9 (approximately $303,041) monthly. The prepaid interest for capital lease obligation is amortized over the life of capital lease agreement using the effective interest method.

 

NOTE K - 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.

 

13
 

 

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 is eligible for additional preferential tax treatment. For the years 2007 and 2008, 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. Thereafter, the Joint Venture would 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 “High-Tech Enterprise” certificate by the Chinese government. The High-Tech Enterprise certificate is valid for three years and provided for a reduced tax rate of 15% for years 2009 through 2011. The Company used a tax rate of 25% for the first three quarters of 2012. In December 2012, the Joint Venture passed the re-assessment of the High-Tech Enterprise certificate by the government, according to relevant PRC income tax laws. Accordingly, it continues to be taxed at a 15% rate in 2012 through 2014.

 

The reconciliation of the effective income tax rate of the Company to the statutory income tax rate in the PRC for the six months of 2014 and 2013 is as follows:

 

   Six months ended
June 30, 2014
   Six months ended
June 30, 2013
 
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%   -10.00%
Tax refund        
Other items   -1.78%   -4.32%
           
Effective tax rate   13.22%   10.68%

 

   Six months ended
June 30, 2014
   Six months ended
June 30, 2013
 
Computed income tax provision at the statutory rate  $2,252,167   $1,627,455 
Tax exemption   (1,164,114)   (728,783)
Tax refund          
Deferred tax provision   (307,428)   (233,688)
Current period permanent differences and other reconciling items   383,820    43,204 
Total income taxes  $1,164,445   $708,188 

 

14
 

 

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 June 30, 2014. 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 December 31, 2014. In the six months ended June 30, 2014, 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 six months ended June 30, 2014 and 2013, respectively, are summarized as follows:

 

   Six months ended
June 30, 2014
   Six months ended
June 30, 2013
 
         
Current  $1,471,873   $941,876 
Deferred   (307,428)   (233,688)
           
Total  $1,164,445   $708,188 

 

As of June 30, 2014 and December 31, 2013, the Company had no unrecognized tax benefits.

 

NOTE L - NONCONTROLLING INTEREST IN SUBSIDIAIRES

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest, owned by the Ruili Group, 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 $740,818 and $652,438 for the six months ended June 30, 2014 and 2013, respectively.

 

   June 30, 2014   June 30, 2013 
         
10% non-controlling interest in Ruian  $784,422   $577,425 
           
40% non-controlling interest in SIH   (43,604)   75,013 
           
Total  $740,818   $652,438 

 

NOTE M – OPERATING LEASES WITH RELATED PARTIES

 

In December 2006, Ruian entered into a lease agreement with Ruili Group 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 2013 to December 2016. This lease was amended in 2013, with a new lease term from January 1, 2013 to December 31, 2022. The annual lease expense is RMB2,100,000 (approximately $333,688).

 

In May 2009, Ruian entered into a lease agreement with Ruili Group for the lease of a manufacturing plant. The lease term is from September 2009 to May 2017. In August 2010, a new lease agreement was signed between Ruian and Ruili Group, under which Ruian leased 32,410 square meters manufacturing plant for its new purchased Passenger Vehicle Brake Systems business. The lease term is from September 2009 to August 2020. This lease was amended in 2013. The amended lease term is from January 1, 2013 to December 31, 2017. The annual lease expense is RMB8, 137,680 (approximately $1,293,070).

 

15
 

 

The lease expenses were $814,389 and $814,389 for the six months ended June 30, 2014 and 2013, respectively.

 

NOTE N - WARRANTY CLAIMS

 

Warranty claims were $1,143,342 and $1,023,349 for the six months ended June 30, 2014 and June 30, 2013, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The movement of accrued warranty expenses for the six months ended June 30, 2014 was as follows:

 

Beginning balance at January 1, 2014  $4,665,439 
Aggregate reduction for payments made   (634,836)
Aggregate increase for new warranties issued during current period   1,143,342 
Aggregate changes in the liability related to pre-existing warranties (changes in estimate)    
Ending balance at June 30, 2014:  $5,173,945 

 

NOTE O – SEGMENT INFORMATION

 

The Company produces brake systems and other related components for different types of commercial vehicles (“Commercial Vehicle Brake Systems”). 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 Vehicle Brake Systems”) of Ruili Group. 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 Vehicle Brake Systems and Passenger Vehicle Brake Systems.

 

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.

 

16
 

 

   Six Months Ended June 30, 
   2014   2013 
         
NET SALES TO EXTERNAL CUSTOMERS          
Commercial Vehicle Brake Systems  $93,874,970   $80,954,463 
Passenger Vehicle Brake Systems   21,842,065    17,874,701 
           
Net sales  $115,717,035   $98,829,164 
INTERSEGMENT SALES          
Commercial Vehicle Brake Systems  $   $ 
Passenger Vehicle Brake Systems        
           
Intersegment sales  $   $ 
GROSS PROFIT          
Commercial Vehicle Brake Systems  $27,485,904   $23,793,067 
Passenger Vehicle Brake Systems   6,414,917    5,252,855 
           
Gross profit  $33,900,821   $29,045,922 
Other operating income   925,262    835,892 
Selling and distribution expenses   12,178,605    9,319,843 
General and administrative expenses   9,027,028    9,383,277 
Research and development expenses   3,691,757    3,007,611 
Income  from operations   9,928,693    8,171,083 
Financial Expenses   (1,138,941)   (1,438,338)
Other income   251,596    91,353 
           
Non-operating expenses   (233,308)   (195,301)
Income  before income tax expense  $8,808,040   $6,628,797 
CAPITAL EXPENDITURE          
Commercial Vehicle Brake Systems  $1,670,876   $1,827,244 
Passenger Vehicle Brake Systems   390,786    392,445 
           
Total  $2,061,662   $2,219,689 
DEPRECIATION AND AMORTIZATION          
Commercial Vehicle Brake Systems  $3,022,678   $2,984,076 
Passenger Vehicle Brake Systems   709,703    641,039 
           
Total  $3,732,381   $3,625,115 

 

   June 30, 2014   December 31, 2013 
           
TOTAL ASSETS          
Commercial Vehicle Brake Systems  $221,356,996   $205,310,702 
Passenger Vehicle Brake Systems   51,503,548    47,669,582 
           
Total  $272,860,544   $252,980,284 

 

17
 

 

   June 30, 2014   December 31, 2013 
           
LONG LIVED ASSETS          
Commercial Vehicle Brake Systems  $49,916,631   $50,413,024 
Passenger Vehicle Brake Systems   11,614,196    11,705,029 
           
Total  $61,530,827   $62,118,053 

 

NOTE P – 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 and the building on the land from Ruili Group for approximately $20 million on September 28, 2007. The Company has not yet obtained the land use right certificate nor the property ownership certificate of the building.

 

(2)The Company provides guarantees to the loans obtained by Ruili Group from the Bank of Ningbo in the amount of RMB108,000,000 (approximately $17,182,404) for the period from September 26, 2013 to September 25, 2014.

 

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 consolidated unaudited financial statements, as well as information relating to the plans of our current management. The following discussion and analysis should be read in conjunction with our consolidated unaudited financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-Q.

 

FORWARD-LOOKING STATEMENTS

 

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 “believe,” “anticipate,” “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 SEC from time to time, which could cause actual results or outcomes to differ materially from those anticipated. Some of the factors that could cause actual results to differ include: our ability to effectively implement our business strategy; our ability to handle downward pricing pressures on our products; our ability to accurately or effectively plan our production or supply needs. For a discussion of these and all other known risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013, which is available on the SEC’s website at www.sec.gov. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to revise or update these forward-looking statements.

 

18
 

 

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 (by sales volume) of automotive brake systems in China for commercial vehicles such as trucks and buses.

 

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, 2013.

 

See Note K to the attached Unaudited 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 June 30, 2014 as compared to the three months ended June 30, 2013.

 

Sales

 

   Three Months ended   Three Months ended 
   June 30, 2014   June 30, 2013 
   (U.S.  dollars in millions) 
Commercial Vehicle Brake Systems  $53.9    82.0%  $46.9    81.6%
Passenger Vehicle Brake Systems  $11.8    18.0%  $10.6    18.4%
                     
Total  $65.7    100.0%  $57.5    100.0%

 

Net sales were $65,723,746 and $57,511,004 for the three months ended June 30, 2014 and 2013, respectively, an increase of $8.2 million or 14.3%. The increase was due to the increased sales to China market and international market.

 

The sales from Commercial Vehicle Brake Systems increased by $7.0 million or 14.9%, to $53.9 million for the second fiscal quarter of 2014, compared to $46.9 million for the same period of 2013. Our high quality, low cost products continued to generate higher sales and further penetrated the commercial vehicle market, which impacted the sales of the Commercial Vehicle Brake Systems.

 

19
 

 

The sales from Passenger Vehicle Brake Systems increased by $1.2 million or 11.3%, to $11.8 million for the second fiscal quarter of 2014, compared to $10.6 million for the same period of 2013. The increase was mainly due to the increase of the passenger vehicle sales in China in the second fiscal quarter of 2014, which increased by 12.3% to 4.76 million units from 4.24 million units for the same period last year.

 

A breakdown of net sales revenue for China OEM market, China aftermarket and international market for the second fiscal quarter of the 2014 and 2013, respectively, is set forth below:

 

   Three
Months
   Percent   Three
Months
   Percent     
   ended   of   ended   of   Percentage 
   June 30, 2014   Total Sales   June 30, 2013   Total Sales   Change 
   (U.S. dollars in million) 
China OEM market  $31.9    48.6%  $30.6    53.2%   4.2%
China Aftermarket  $15.4    23.4%  $12.8    22.3%   20.3%
International market  $18.4    28.0%  $14.1    24.5%   30.5%
Total  $65.7    100.0%  $57.5    100.0%   14.3%

  

Considering the decline of the production and sales of the commercial vehicles in the second fiscal quarter of 2014 in the automobile industry, the OEM manufacturers were facing higher pressure from market this year. Therefore, they paid more attention to the quality and cost controls. Compared with some smaller auto parts manufacturers, we had better quality and cost controls on our products. As a result, our sales to the China OEM market increased by 4.2% from the second fiscal quarter of 2013, to $31.9 million. This increase is in contrast to the 14.4% decline in unit truck sales in Chinese automobile industry during the second fiscal quarter of 2014.

 

Our sales to the China aftermarket increased by $2.6 million or 20.3%, to $15.4 million for the second fiscal quarter of 2014, compared to $12.8 million for the same period of 2013. The reasons of the increase are: (1) Our large portfolio of products, with more new products, for the aftermarket provides us with a competitive advantage, enabling us to further penetrate and capture additional share in this segment; (2) To increase our market share, we did product promotion (price adjustment) in the second fiscal quarter of 2014; and (3) Accelerated urbanization and the Chinese government's increased support for public transportation favor our expansion in the bus aftermarket. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets.

 

Our export sales increased by $4.3 million or 30.5%, to $18.4 million for the second fiscal quarter of 2014, as compared to $14.1 million for the same period of 2013. A part of our strategy is to strengthen and extend our distribution networks to increase our exposure with end users. The increase in export sales was mainly due to our broadened customer base.

 

Cost of Sales and Gross Profit

 

Cost of sales for the three months ended June 30, 2014 were $47,209,861 an increase of $6,520,956 or 16.0% from $40,688,905 for the three month period ended June 30, 2013. Our gross profit increased by 10.1% from $16,822,099 for the second quarter of 2013 to $18,513,885 for the three month period ended June 30, 2014.

 

Gross margin decreased to 28.2% from 29.3% for the three month period ended June 30, 2014 compared with the same period of 2013. One of the reasons of the decrease is that, to strengthen our competitiveness and increase our market share, we started the price promotion in the aftermarket in the second fiscal quarter of 2014. The increased labor cost also decreased our gross margin for the three month period ended June 30, 2014. We intend to focus in 2014 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.

 

20
 

 

Cost of sales from Commercial Vehicle Brake Systems for the three months period ended June 30, 2014 were $38.7 million, an increase of $5.5 million or 16.6% from $33.2 million for the same period last year. The gross profit from Commercial Vehicle Brake Systems increased by 10.9% from $13.7 million for three month period ended June 30, 2013 to $15.2 million for the three month period ended June 30, 2014. Gross margin from Commercial Vehicle Brake Systems decreased to 28.2% from 29.2% for the three months period ended June 30, 2014 compared to the three month period ended June 30, 2013.

 

Cost of sales from Passenger Vehicle Brake Systems for the three months period ended June 30, 2014 were $8.5 million, an increase of $1.0 million or 13.3% from $7.5 million for the three month period ended June 30, 2013. The gross profit from Passenger Vehicle Brake Systems increased by 6.5% from $3.1 million for the three month period ended June 30, 2013 to $3.3 million for the three month period ended June 30, 2014. Gross margin from Passenger Vehicle Brake Systems decreased to 28.0% from 29.2% for the three months ended June 30, 2014, as compared with the same period in 2013.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were $6,473,111 for the three months ended June 30, 2014, as compared to $4,911,344 for the same period of 2013, an increase of $1,561,767 or 31.8%.

 

The increase was mainly due to increased freight expense and packaging expenses. As a percentage of sales revenue, selling expenses increased to 9.8% for the three months ended June 30, 2014, as compared to 8.5% for the same period in 2013.

 

General and Administrative Expenses

 

General and administrative expenses were $4,710,874 for the three months ended June 30, 2014, as compared to $5,220,131 for the same period of 2013, a decrease of $509,257 or 9.8%. The decrease was mainly due to the decrease in allowance for doubtful accounts. In the second fiscal quarter of 2014, as compared to the same period in 2013, our allowance for doubtful accounts decreased, because we had less overdue account receivables. As a percentage of sales revenue, general and administrative expenses decreased to 7.2% for the three months ended June 30, 2014, as compared to 9.1% for the same period in 2013.

 

Research and Development Expenses

 

Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development costs. For the three months ended June 30, 2014, research and development expenses were $2,200,558, as compared to $1,617,147 for the same period of 2013, an increase of $583,411.

 

Other Operating Income

 

Other operating income was $549,130 for the three months ended June 30, 2014, as compared to $632,105 for the three months ended June 30, 2013, a decrease of $82,975. The decrease was mainly due to a decrease in sales of raw material scraps for the three months ended June 30, 2014.

 

Depreciation and Amortization

 

Depreciation and amortization expense decreased to $1,879,071 for the three months ended June 30, 2014, compared with that of $1,809,808 for the same period of 2013, an increase of $69,263. The increase in depreciation and amortization expense was primarily due to the addition of purchased production equipment.

 

21
 

 

Financial Expenses

 

Financial expenses mainly consist of interest expenses, the financing expenses associated with our capital lease transaction and exchange loss. The financial expenses for the three months ended June 30, 2014, decreased by $13,036 to $479,058 from $492,094 for the same period of 2013, which was mainly due to the decreased interest expense related to bank loans and discounted bank and trade acceptance notes.

 

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 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 "High-Tech Enterprise" certificate by the Chinese government. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate for years 2009 through 2011. The Company used a tax rate of 25% for the first three quarters of 2012. In December 2012, the Joint Venture passed the re-assessment of the High-Tech Enterprise certificate by the government, according to the relevant PRC income tax laws. Accordingly, it continues to be taxed at a 15% rate in 2012 through 2014.

 

Income tax expense was $651,210 for the three months ended June 30, 2014, as compared to $539,334 for the three months ended June 30, 2013. The increase was mainly due to increased pre-tax income.

 

Net Income Attributable to Non-Controlling Interest in Subsidiaries

 

Noncontrolling interest in subsidiaries represents a 10% noncontrolling interest in Ruian and 40% noncontrolling interest in SIH, in each case held by our Joint Venture partners. Net income attributable to noncontrolling interest in subsidiaries amounted to $447,621 and $512,138 for the second fiscal quarter ended June 30, 2014 and 2013, respectively.

 

Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the fiscal quarter ended June 30, 2014, increased by $97,682, to $4,132,474 from $4,034,792 for the fiscal quarter ended June 30, 2013 due to increased net income, which was caused by increased sales. The main factors contributing to our sales increase in the fiscal quarter ended June 30, 2014 include expansion of our portfolio of products and our adoption of product promotion strategy. Earnings per share (“EPS”), both basic and diluted, for the fiscal quarter ended June 30, 2014 and 2013, were both $0.21.

  

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Results of operations for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013.

 

Sales

  

   Six months ended   Six months ended 
   June 30, 2014   June 30, 2013 
   (U.S.  dollars in millions) 
Commercial Vehicle Brake Systems  $93.9    81.2%  $80.9    81.9%
Passenger Vehicle Brake Systems  $21.8    18.8%  $17.9    18.1%
                     
Total  $115.7    100.0%  $98.8    100.0%

 

Net sales were $115,717,035 and $98,829,164 for the six months ended June 30, 2014 and 2013, respectively, an increase of $16.9 million or 17.1%. The increase was due to the increased sales to China market and international market.

 

The sales from Commercial Vehicle Brake Systems increased by $13.0 million or 16.1%, to $93.9 million for the six months ended June 30, 2014, compared to $80.9 million for the same period of 2013. Due to the recovery of the commercial vehicle market in the six months ended June 30, 2014, the sales from the OEM market increased, which impacted the sales of the Commercial Vehicle Brake Systems.

 

The sales from Passenger Vehicle Brake Systems increased by $3.9 million or 21.8%, to $21.8 million for the six months ended June 30, 2014, compared to $17.9 million for the same period of 2013. The increase was mainly due to the increase of the passenger vehicle sales in China in the first six months of 2014, which was increased by 11.2% to 9.63 million units from 8.67 million units for the same period last year.

 

A breakdown of net sales revenues for China OEM markets, China aftermarket and international market for the six months ended June 30, 2014 and 2013, respectively, is set forth below:

 

       Percent  

Six

months

   Percent     
   Six months   of   ended   of     
   ended
June 30, 2014
  

Total

Sales

  

June 30,

2013

  

Total

Sales

   Percentage
Change
 
   (U.S. dollars in million)     
China OEM market  $60.5    52.3%  $53.4    54.0%   13.3%
China Aftermarket  $25.9    22.4%  $22.0    22.3%   17.7%
International market  $29.3    25.3%  $23.4    23.7%   25.2%
Total  $115.7    100.0%  $98.8    100.0%   17.1%

 

Considering the decline of the production and sales of the commercial vehicles in the six months of 2014 in the automobile industry, the OEM manufacturers were facing higher pressure from market this year. Therefore, they paid more attention to the quality and cost controls. Compared with some smaller auto parts manufacturers, we had better quality and cost controls on our products. As a result, our sales to the China OEM market increased by 13.3% from the six months ended June 30, 2014, to $60.5 million.

 

Our sales to the China aftermarket increased by $3.9 million or 17.7%, to $25.9 million for the six months ended June 30, 2014, compared to $22.0 million for the same period of 2013. The reasons of the increase are: (1) Our large portfolio of products, with more new products for the aftermarket provides us with a competitive advantage, enabling us to further penetrate and capture additional share in this segment; (2) To increase our market share, we did product promotion (price adjustment) in the second fiscal quarter of 2014; and (3) Accelerated urbanization and the Chinese government's increased support for public transportation favor our expansion in the bus aftermarket. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets.

 

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Our export sales increased by $5.9 million or 25.2%, to $29.3 million for the six months ended June 30, 2014, as compared to $23.4 million for the same period of 2013. A part of our strategy is to strengthen and extend our distribution networks to increase our exposure with end users. The increase in export sales was mainly due to our broadened customer base.

 

Cost of Sales and Gross Profit

 

Cost of sales for the six months ended June 30, 2014 were $81,816,214, an increase of $12,032,972 or 17.2% from $69,783,242 for the same period last year. Our gross profit increased by 16.7% from $29,045,922 for the six months ended June 30, 2013 to $33,900,821 for the same period of 2014.

 

Gross margin decreased to 29.4% from 29.5% for the six months ended June 30, 2014, as compared with the same period of 2013. One of the reasons of the decrease is that, to strengthen our competitiveness and increase our market share, we started the price promotion in the aftermarket in the second fiscal quarter of 2014. The increased labor cost also decreased our gross margin for the six month period ended June 30, 2014. We intend to focus in 2014 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.

 

Cost of sales from Commercial Vehicle Brake Systems for the six months ended June 30, 2014 were $66.4 million, an increase of $9.3 million or 16.3% from $57.1 million for the same period of 2013. The gross profit from Commercial Vehicle Brake Systems increased by 15.5% from $23.8 million for the six months ended June 30, 2013 to $27.5 for the same period of 2014. Gross margin from Commercial Vehicle Brake Systems decreased to 29.3% from 29.4% for the six months ended June 30, 2014 compared with the same period of 2013.

 

Cost of sales from Passenger Vehicle Brake Systems for the six months ended June 30, 2014 were $15.4 million, an increase of $2.7 million or 21.3% from $12.7 million for the same period of 2013. The gross profit from Passenger Vehicle Brake Systems increased by 23.1% from $5.2 for the six months ended June 30, 2013 to $6.4 for the same period of 2014. Gross margin from Passenger Vehicle Brake Systems increased to 29.4% from 29.1% for the six months ended June 30, 2014, as compared with the same period in 2013.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were $12,178,605 for the six months ended June 30, 2014, as compared to $9,319,843 for the same period of 2013, an increase of $2,858,762 or 30.7%.

 

The increase was mainly due to increased freight expense and packaging expenses. As a percentage of sales revenue, selling expenses increased to 10.5% for the six months ended June 30, 2014, as compared to 9.4% for the same period in 2013.

 

General and Administrative Expenses

 

General and administrative expenses were $9,027,028 for the six months ended June 30, 2014, as compared to $9,383,277 for the same period of 2013, a decrease of $356,249 or 3.8%.

 

The decrease was mainly due to the decrease in allowance for doubtful accounts. In the second fiscal quarter of 2014, as compared to the same period in 2013, our allowance for doubtful accounts decreased, because we had less overdue account receivables. As a percentage of sales revenue, general and administrative expenses decreased to 7.8% for the six months ended June 30, 2014, as compared to 8.1% for the same period in 2013.

 

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Research and Development Expenses

 

Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development costs. For the six months ended June 30, 2014, research and development expenses were $3,691,757, as compared to $3,007,611 for the same period of 2013, an increase of $684,146.

 

Other Operating Income

 

Other operating income was $925,262 for the six months ended June 30, 2014, as compared to $835,892 for the six months ended June 30, 2013, an increase of $89,370. The increase was mainly due to an increase in sales of raw material scrap for the six months ended June 30, 2014.

 

Depreciation and Amortization

 

Depreciation and amortization expenses increased to $3,732,381 for the six months ended June 30, 2014, compared with that of $3,625,115 for the same period of 2013, an increase of $107,266. The increase in depreciation and amortization expenses was primarily due to the purchase of production equipment.

 

Financial Expenses

 

Financial expenses mainly consist of interest expenses, the financing expense associated with our capital lease transaction and exchange losses. The financial expenses for the six months ended June 30, 2014, decreased by $299,397 to $1,138,941 from $1,438,338 for the same period of 2013, which was mainly due to decreased exchange losses and interest expense.

 

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 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 "High-Tech Enterprise" certificate by the Chinese government. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate for years 2009 through 2011. The Company used a tax rate of 25% for the first three quarters of 2012. In December 2012, the Joint Venture passed the re-assessment of the High-Tech Enterprise certificate by the government, according to the relevant PRC income tax laws. Accordingly, it continues to be taxed at a 15% rate in 2012 through 2014.

 

Income tax expense was $1,164,445 for the six months ended June 30, 2014, as compared to $708,188 for the six months ended June 30, 2013. The increase was mainly due to increased pre-tax income.

 

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. Each of the non-controlling interest is held by our Joint Venture partners. Net income attributable to non-controlling interest in subsidiaries amounted to $740,818 and $652,438 for the six months ended June 30, 2014 and 2013, respectively.

 

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Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the six months ended June 30, 2014, increased by $1,634,606, to $6,902,777 from $5,268,171 for the six months ended June 30, 2013 due to increased net income, which was caused by increased sales. The main factors contributing to our sales increase in the six months ended June 30, 2014 include expansion of our portfolio of products and our adoption of product promotion strategy. Earnings per share (“EPS”), both basic and diluted, for the six months ended June 30, 2014 and 2013, were $0.36 and $0.27, respectively.

 

FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

As of June 30, 2014, the Company had cash and cash equivalents of $27,020,085, as compared to cash and cash equivalents of $28,241,983 as of December 31, 2013. The Company had working capital of $155,521,961 at June 30, 2014, as compared to working capital of $144,658,883 at December 31, 2013, reflecting current ratios of 3.79:1 and 4.13:1, respectively.

 

OPERATING - Net cash used in operating activities was $4,379,173 for six months ended June 30, 2014 a decrease of $5,378,556, as compared with $999,383 of net cash provided by operating activities in the same period in 2013. Such decrease was primarily due to the increased cash outflow resulted by changes in accounts receivable.

 

INVESTING - During the six months ended June 30, 2014, the Company expended net cash of $2,008,225 in investing activities mainly for acquisition of new equipment to support the growth of the business. For the six months ended June 30, 2013, the Company expended net cash of $2,219,689 in investing activities.

 

FINANCING - During the six month period ended June 30, 2014, the cash provided by financing activities was $4,540,724. Cash used in financing activities was $2,749,989 for the six months ended June 30, 2013.

 

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.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

As of June 30, 2014, 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.

 

According to the laws 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 the Ruili Group, a related party. The Company also purchased a building on the land in the same transaction. The purchase price of land use right and building amounted to approximately $20 million.

 

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. Because of the change in personnel of the local government, there is no new development of negotiations regarding taxes related to the land use rights. Due to the lack of resolution of that issue, the land use right certificate and the property ownership certificate have not been issued to the Company. There is no assurance that we can conclude the negotiations with the government and obtain a favorable result. We plan to conclude negotiations with the government and to obtain the land use rights certificate as soon as practicable.

 

26
 

 

Even if the Company is unable to timely resolve obtain the land use right certificate for the land and related building, there will be no potential adverse implication on the Company for the following reasons.

 

1.      The Company acquired the land use rights in a transaction between the Company and Ruili Group, a related party. Ruili Group, as the original land use right owner, has granted the land use right to the Company by contract which is supported by valid consideration.

 

2.     No third party would oppose the Company’s use of the land, because no third party has any interest in the land use right or property ownership right, other than the Ruili Group and the government.

 

a)      The Ruili Group promised that the Company has the right to use the land and related building, even before the land use certificate is transferred.

 

b)      According to the laws of China, the government owns all the land and the buildings attached to the land in China. Once the land use right is granted to Ruili Group, Ruili Group has the right to assign its land use rights to any third parties, including the Company, without interference from the government. Therefore, it is unlikely for the government to oppose the Company’s right to use the land and related building.

 

c)      The Company has made tax payments in full to the local government as if no reduction or exemption of tax is approved. Therefore, even if the reduction in tax request is rejected, the Company would not be liable for a substantial amount of taxes to the local government.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures:

 

As of the end of the period covered by this report, the management, including our Chief Executive Officer and Chief 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 Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures as of June 30, 2014 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 six months ended June 30, 2014 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

 

None.

 

ITEM 1A. RISK FACTORS

 

Not applicable.

 

27
 

 

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

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

3.1   Amended and Restated Articles of Incorporation, as further amended. (1)
     
3.2   Amended and Restated Bylaws effective as of March 14, 2009. (2)
     
31.1   Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32   Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (3)

  

(1)Incorporated herein by reference from the Registrant’s Form 8-K Current Report as filed with the Securities and Exchange Commission, on June 1, 2010.

 

(2)Incorporated herein by reference from the Registrant’s Form 8-K Current Report as filed with the Securities and Exchange Commission, on March 17, 2009.

 

(3)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.

 

28
 

 

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 : August 14, 2014 SORL AUTO PARTS, INC.
   
  By: /s/ Xiao Ping Zhang
  Name: Xiao Ping Zhang
  Title: Chief Executive Officer
  (Principal Executive Officer)
   
  By: /s/ Zong Yun Zhou
  Name: Zong Yun Zhou
 

Title: Chief Financial Officer

(Principal Financial Officer)

 

29