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EX-32 - EXHIBIT 32 - SORL Auto Parts Incv393620_ex32.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 September 30, 2014

 

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

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 definitions 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 November 14, 2014 there were 19,304,921 shares of common stock outstanding

 

 
 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Quarter Ended September 30, 2014

 

INDEX

 

    Page
     
PART I. FINANCIAL INFORMATION (Unaudited)  
     
Item 1. Financial Statements:  
     
  Consolidated Balance Sheets as of September 30, 2014 (Unaudited) and December 31, 2013 3
     
  Consolidated Statements of Income and Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013 (Unaudited) 4
     
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (Unaudited) 5
     
  Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 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. Contractual Obligations 27
     
Item 4. Quantitative and Qualitative Disclosures About Market Risk 27
     
Item 5. Controls and Procedures 27
     
PART II. OTHER INFORMATION 28
     
Item 1. Legal Proceedings. 28
     
Item 1A. Risk Factors. 28
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 28
     
Item 3. Defaults Upon Senior Securities. 28
     
Item 4. 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

September 30, 2014 and December 31, 2013

 

   September 30, 2014   December 31, 2013 
   (Unaudited)   (Audited) 
Assets          
Current Assets          
Cash and cash equivalents

 

US$37,902,347 

 

US$28,241,983 
Accounts receivable, net of provision   65,347,362    57,912,384 
Bank acceptance notes from customers   14,390,355    20,186,787 
Inventories   81,310,370    76,364,019 
Prepayments   6,595,695    3,773,750 
Current portion of prepaid capital lease interest   326,269    453,053 
Other current assets   1,871,590    2,537,300 
Deferred tax assets   1,829,624    1,392,955 
Total Current Assets   209,573,612    190,862,231 
Fixed Assets          
Machinery   50,225,617    46,475,961 
Molds   1,418,227    1,388,218 
Office equipment   2,110,131    1,960,476 
Vehicles   2,062,119    2,248,280 
Buildings   9,103,122    8,910,501 
Machinery held under capital lease   29,012,601    28,396,853 
Less: accumulated depreciation   (50,114,599)   (44,175,888)
Property, plant and equipment, net   43,817,218    45,204,401 
Leasehold improvements   220,632    264,612 
           
Land Use Rights, Net   14,437,566    14,409,170 
           
Other Non-Current Assets          
           
Intangible assets   81,051    176,302 
Less: accumulated amortization   (40,526)   (126,031)
Intangible assets, net   40,525    50,271 
Security deposits on lease agreement   1,857,549    1,818,244 
Non-current portion of prepaid capital lease interest   151,753    371,355 
Total Other Non-Current Assets   2,049,827    2,239,870 
Total Assets  US$270,098,855   US$252,980,284 
           
Liabilities and Shareholders' Equity          
Current Liabilities          
Accounts payable, including $792,275 and $810,310 due to related parties at September 30, 2014 and December 31, 2013, respectively.  US$8,627,664   US$13,290,282 
Deposit received from customers   15,733,550    13,931,658 
Short term bank loans   8,187,452    4,526,863 
Income tax payable   477,655    494,658 
Accrued expenses   12,324,370    10,066,969 
Current portion of capital lease obligations   3,715,098    3,636,488 
Other current liabilities, including $203,560 and $94,246 due to related parties at September 30, 2014 and December 31, 2013, respectively.   1,853,114    256,430 
Total Current Liabilities   50,918,903    46,203,348 
           
Non-Current Liabilities          
Non-current portion of capital lease obligations   4,643,873    7,272,975 
Total Non-Current Liabilities   4,643,873    7,272,975 
           
Total Liabilities  US$55,562,776   US$53,476,323 
           
Stockholders' Equity          
           
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of September 30, 2014 and December 31, 2013   -    - 
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of September 30, 2014 and December 31, 2013   38,609    38,609 
Additional paid-in capital   42,199,014    42,199,014 
Reserves   11,600,638    10,609,435 
Accumulated other comprehensive income   26,357,421    22,465,720 
Retained earnings   113,356,629    104,544,120 
Total SORL Auto Parts, Inc. Stockholders' Equity   193,552,311    179,856,898 
Noncontrolling Interest In Subsidiaries   20,983,768    19,647,063 
Total Equity   214,536,079    199,503,961 
Total Liabilities and Stockholders' Equity  US$270,098,855   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 Nine Months Ended September 30, 2014 and 2013 (Unaudited)

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2014   2013   2014   2013 
                 
Sales  US$58,702,505 

 

US$54,488,640 

 

US$174,419,540 

 

US$153,317,804 
Include: sales to related parties   534,195    825,101    2,169,778    2,067,673 
Cost of sales   43,240,746    39,075,431    125,056,960    108,858,673 
                     
Gross profit   15,461,759    15,413,209    49,362,580    44,459,131 
Expenses:                    
Selling and distribution expenses   5,871,463    5,277,020    18,050,068    14,596,863 
General and administrative expenses   3,759,307    3,696,715    12,786,335    13,079,992 
Research and development expenses   2,242,620    2,384,902    5,934,377    5,392,513 
                     
Total operating expenses   11,873,390    11,358,637    36,770,780    33,069,368 
                     
Other operating income   545,752    444,791    1,471,014    1,280,683 
                     
Income from operations   4,134,121    4,499,363    14,062,814    12,670,446 
                     
Other income   100,534    413,862    352,130    505,215 
Financial expenses   (634,282)   (770,418)   (1,773,223)   (2,208,756)
Non-operating expenses   (44,637)   (77,073)   (277,945)   (272,374)
                     
Income before provision for income taxes   3,555,736    4,065,734    12,363,776    10,694,531 
                     
Provision for income taxes   391,988    332,027    1,556,433    1,040,215 
                     
Net income

 

US$3,163,748   US$3,733,707   US$10,807,343   US$9,654,316 
                     
Net income attributable to noncontrolling interest in subsidiaries   262,813    423,087    1,003,631    1,075,525 
                     
Net income attributable to common stockholders  US$2,900,935   US$3,310,620   US$9,803,712 

 

US$8,578,791 
                     
Comprehensive income:                    
                     
Net income  US$3,163,748   US$3,733,707   US$10,807,343   US$9,654,316 
                     
Foreign currency translation adjustments   (108,081)   1,023,444    4,224,775    4,833,515 
                     
Comprehensive income   3,055,667    4,757,151    15,032,118    14,487,831 
                     
Comprehensive income attributable to noncontrolling interest in subsidiaries   193,652    532,333    1,336,705    1,564,259 
                     
Comprehensive income attributable to common shareholders  US$2,862,015   US$4,224,818 

 

US$13,695,413   US$12,923,572 
                     
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$0.15   US$0.17   US$0.51   US$0.44 
                     
EPS - diluted  US$0.15   US$0.17    US$0.51   US$0.44 

  

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 Nine Months Ended September 30, 2014 and 2013 (Unaudited)

 

   Nine Months Ended September 30, 
   2014   2013 
         
Cash Flows from Operating Activities          
Net income  US$10,807,343    US$9,654,316 
Adjustments to reconcile net income to net cash           
from operating activities:          
           
Allowance for doubtful accounts   1,697,068    1,371,727 
Depreciation and amortization   5,597,867    5,617,369 
Deferred income tax   (405,594)   (252,018)
Loss on disposal of fixed assets   35,655    5,196 
Changes in assets and liabilities:          
Account receivable   (7,790,502)   8,037,713 
Bank acceptance notes from customers   6,153,022    (12,252,121)
Other currents assets   755,849    (1,756,558)
Inventories   (3,305,061)   (12,687,012)
Prepayments   (2,716,212)   (319,823)
Prepaid capital lease interest   362,790    342,776 
Accounts payable   (4,895,398)   (6,259,596)
Income tax payable   (26,461)   - 
Deposits received from customers   1,506,420    7,317,768 
Other current liabilities and accrued expenses   3,630,457    2,248,257 
           
Net Cash Flows Provided By Operating Activities   11,407,243    1,067,994 
           
Cash Flows from Investing Activities          
Acquisition of property and equipment   (2,994,571)   (3,356,852)
Proceeds of disposal of fixed assets   57,339    14,602 
Net Cash Flows Used In Investing Activities   (2,937,232)   (3,342,250)
           
Cash Flows from Financing Activities          
Proceeds from bank loans   28,383,953    60,307,996 
Repayment of bank loans   (24,924,952)   (69,079,151)
Repayment of capital lease   (2,776,407)   (11,400,163)
Proceeds from capital lease   -    12,783,841 
Net Cash flows Provided By (Used In) Financing Activities   682,594    (7,387,477)
           
Effects on changes in foreign exchange rate   507,759    928,771 
           
Net change in cash and cash equivalents   9,660,364    (8,732,962)
           
Cash and Cash Equivalents- Beginning of the Year   28,241,983    41,253,353 
           
Cash and Cash Equivalents - End of the Period  US$37,902,347   US$32,520,391 
           
Supplemental Cash Flow Disclosures:          
Interest paid  US$1,126,215   US$1,247,619 
Tax paid  US$1,983,823   US$1,772,230 

 

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 Nine Months Ended September 30, 2014 (Unaudited)

 

           Additional           Accumu. Other             
   Number   Common   Paid-in       Retained   Comprehensive   Shareholders'   Noncontrolling   Total 
   of Shares   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   -    -    -    -    9,803,712    -    9,803,712    1,003,631    10,807,343 
                                              
Foreign currency translation adjustment   -    -    -    -    -    3,891,701    3,891,701    333,074    4,224,775 
                                              
Transfer to reserve   -    -    -    991,203    (991,203)   -    -    -    - 
                                              
Ending Balance - September 30, 2014   19,304,921   $38,609   $42,199,014   $11,600,638   $113,356,629   $26,357,421   $193,552,311   $20,983,768   $214,536,079 

 

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

September 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 specializes 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 US $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, and accounts receivable at book values of US $8.0 million, US $8.0 million and US $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 (“SEC”), 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. 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 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, “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.

 

In August 2014, the FASB issued ASU 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”. The amendment in the ASU provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Earlier adoption is permitted. The Company does not expect the adoption to have a significant impact on its consolidated financial statements.

 

9
 

 

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.

 

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

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2014   2013   2014   2013 
                 
PURCHASES FROM:                    
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.  $178,095   $   $1,650,115   $551,457 
Ruian Kormee Vehicle Brake Co., Ltd.   326,002    692,079    1,095,959    1,508,268 
The Ruili Group   862,037    1,302,818    2,905,090    3,349,422 
                     
Total Purchases  $1,366,134   $1,994,897   $5,651,164   $5,409,147 
                     
SALES TO:                    
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.  $153,236   $307,816   $1,127,947   $597,387 
Ruian Kormee Vehicle Brake Co., Ltd.   12,743    22,135    68,482    22,135 
The Ruili Group   368,216    495,150    973,349    1,448,151 
                     
Total Sales  $534,195   $825,101   $2,169,778   $2,067,673 

 

   September 30,   December 31, 
   2014   2013 
ACCOUNTS PAYABLE          
Ruian Kormee Vehicle Brake Co., Ltd.  $38,490   $445,896 
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.   728,641     
The Ruili Group   25,144    364,414 
Total  $792,275   $810,310 
           
OTHER PAYABLES          
MGR Hong Kong Limited  $180,099   $94,246 
The Ruili Group   23,461     
Total  $203,560   $94,246 

 

10
 

 

The Company entered into several lease agreements with a related party, the Ruili Group, 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 RMB 108,000,000 (approximately $17,182,404) for the period from September 26, 2013 to September 25, 2014.

 

NOTE E - ACCOUNTS RECEIVABLE

 

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

 

   September 30, 2014   December 31, 2013 
Beginning balance  $3,813,415   $998,492 
Add: Increase to allowance   1,782,739    2,814,923 
Less: Accounts written off        
           
Ending balance  $5,596,154   $3,813,415 

 

   September 30,   December 31, 
   2014   2013 
Accounts receivable  $70,943,516   $61,725,799 
Less: allowance for doubtful accounts   (5,596,154)   (3,813,415)
           
Account receivable balance, net  $65,347,362   $57,912,384 

 

11
 

 

NOTE F - INVENTORIES

 

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

 

   September 30, 2014   December 31, 2013 
         
Raw materials  $8,483,140   $12,380,061 
Work in process   35,663,894    31,546,330 
Finished goods   37,192,045    32,466,337 
Less: Write-down of inventories   (28,709)   (28,709)
           
Total inventories  $81,310,370   $76,364,019 

 

NOTE G - PROPERTY, PLANT AND EQUIPMENT

 

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

 

   September 30, 2014   December 31, 2013 
Machinery  $50,225,617   $46,475,961 
Molds   1,418,227    1,388,218 
Office equipment   2,110,131    1,960,476 
Vehicles   2,062,119    2,248,280 
Buildings   9,103,122    8,910,501 
Machinery held under capital lease   29,012,601    28,396,853 
           
Sub-Total   93,931,817    89,380,289 
           
Less: Accumulated depreciation   (50,114,599)   (44,175,888)
           
Property, plant and equipment, net  $43,817,218   $45,204,401 

 

Depreciation expense charged to operations was $5,247,145 and $5,101,292 for the nine months ended September 30, 2014 and September 30, 2013, respectively.

 

12
 

 

NOTE H - DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES

 

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

 

   September 30, 2014   December 31, 2013 
Deferred tax assets - current          
Allowance for doubtful accounts  $846,488   $578,928 
Revenue (net of cost)   45,459    8,653 
Unpaid accrued expenses   122,247    105,558 
Warranty   815,430    699,816 
Deferred tax assets   1,829,624    1,392,955 
Valuation allowance        
Net deferred tax assets - current  $1,829,624   $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 U.S. 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 I – SHORT-TERM BANK LOANS

 

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

 

   September 30,   December 31, 
   2014   2013 
Secured  $8,187,452   $4,526,863 

 

The Company obtained those short term loans from Bank of China, Agricultural Bank of China, and China Construction Bank, to finance general working capital as well as new equipment acquisition. Interest rate for the loans ranged from 2.73% to 3.62% per annum. The maturity dates of the loans ranged from November 11, 2014 to November 27, 2015.

 

Corporate or personal guarantee:
$5.1 Million   Guaranteed by the Ruili Group, a related party;
$3.1 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

 

   September 30, 2014   December 31, 2013 
         
Total capital lease obligations  $8,358,971   $10,909,463 
Less: Current portion   (3,715,098)   (3,636,488)
Non-current portion  $4,643,873   $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 US $14,545,950) and the Company is required to maintain a security deposit of RMB 11,428,571 (approximately US $1,818,244). The Company prepaid all interests of RMB 10,705,357 (approximately US $1,703,212) after the discount and is obligated for the payment of RMB 1,904,762 (approximately US $303,041) monthly. The prepaid interest for capital lease obligation is amortized over the life of capital lease agreement using the effective interest method.

 

13
 

 

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.

 

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 nine months of 2014 and 2013 is as follows:

 

   Nine Months Ended
September 30, 2014
   Nine Months
Ended September
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%
Additional deduction allowed for R&D expenses   -3.60%   -4.81%
Other items   1.19%   -0.46%
           
Effective tax rate   12.59%   9.73%

 

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 September 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 nine months ended September 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 nine months ended September 30, 2014 and 2013, respectively, are summarized as follows:

 

   Nine Months Ended
September 30, 2014
   Nine Months Ended
September 30, 2013
 
         
Current  $1,962,026   $1,292,233 
Deferred   (405,593)   (252,018)
           
Total  $1,556,433   $1,040,215 

 

As of September 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 $1,003,631 and $1,075,525 for the nine months ended September 30, 2014 and 2013, respectively.

 

   Nine Months Ended
September 30, 2014
   Nine Months Ended
September 30, 2013
 
         
10% non-controlling interest in Ruian  $1,101,336   $941,410 
40% non-controlling interest in SIH   (97,705)   134,115 
           
Total  $1,003,631   $1,075,525 

 

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 RMB 2,100,000 (approximately US $333,688).

 

15
 

 

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 RMB 8,137,680 (approximately US $1,293,070).

 

The lease expenses were $1,221,583 and $1,220,069 for the nine months ended September 30, 2014 and 2013, respectively.

 

NOTE N - WARRANTY CLAIMS

 

Warranty claims were $1,717,235 and $1,589,950 for the nine months ended September 30, 2014 and September 30, 2013, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The movement of accrued warranty expenses for the nine months ended September 30, 2014 was as follows:

 

Beginning balance at January 1, 2014  $4,665,439 
Aggregate reduction for payments made   (946,477)
Aggregate increase for new warranties issued during current period   1,717,235 
Ending balance at September 30, 2014  $5,436,197 

 

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
 

 

   Nine Months Ended September 30, 
   2014   2013 
         
NET SALES TO EXTERNAL CUSTOMERS          
Commercial Vehicle Brake Systems  $141,967,713   $124,244,854 
Passenger Vehicle Brake Systems   32,451,827    29,072,950 
           
Net sales  $174,419,540   $153,317,804 
INTERSEGMENT SALES          
Commercial Vehicle Brake Systems  $   $ 
Passenger Vehicle Brake Systems        
           
Intersegment sales  $   $ 
GROSS PROFIT          
Commercial Vehicle Brake Systems  $40,178,369   $36,028,550 
Passenger Vehicle Brake Systems   9,184,211    8,430,581 
           
Gross profit  $49,362,580   $44,459,131 
Other operating income   1,471,014    1,280,683 
Selling and distribution expenses   18,050,068    14,596,863 
General and administrative expenses   12,786,335    13,079,992 
Research and development expenses   5,934,377    5,392,513 
Income from operations   14,062,814    12,670,446 
Financial expenses   (1,773,223)   (2,208,756)
Other income   352,130    505,215 
Non-operating expenses   (277,945)   (272,374)
           
Income before income tax expense  $12,363,776   $10,694,531 
CAPITAL EXPENDITURE          
Commercial Vehicle Brake Systems  $2,437,413   $2,730,650 
Passenger Vehicle Brake Systems   557,158    626,202 
           
Total  $2,994,571   $3,356,852 
DEPRECIATION AND AMORTIZATION          
Commercial Vehicle Brake Systems  $4,556,349   $4,552,173 
Passenger Vehicle Brake Systems   1,041,518    1,065,196 
           
Total  $5,597,867   $5,617,369 

 

   September 30,
2014
   December 31,
2013
 
     
TOTAL ASSETS          
Commercial Vehicle Brake Systems  $219,845,303   $205,310,702 
Passenger Vehicle Brake Systems   50,253,552    47,669,582 
           
Total  $270,098,855   $252,980,284 

 

   September 30,
2014
   December 31,
2013
 
     
LONG LIVED ASSETS          
Commercial Vehicle Brake Systems  $49,264,150   $50,413,024 
Passenger Vehicle Brake Systems   11,261,093    11,705,029 
           
Total  $60,525,243   $62,118,053 

 

17
 

 

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. There is no new development of negotiations regarding taxes related to the land use rights. Although the Company plans to conclude negotiations with the local government and to obtain the land use right certificate as soon as practicable, the Company is unable to predict when the negotiations will be resolved or concluded. There is no assurance that the Company can obtain the land use right certificate. Even if it is unable to resolve the tax issues and obtain the land use right certificate for the land and related building, there will be no potential adverse implication on the Company.

 

(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 US $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; and 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.

 

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.

 

18
 

 

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 September 30, 2014 as compared to the three months ended September 30, 2013.

Sales

 

   Three Months Ended   Three Months Ended 
   September 30, 2014   September 30, 2013 
   (U.S.  dollars in millions) 
Commercial Vehicle Brake Systems  $48.1    81.9%  $43.3    79.4%
Passenger Vehicle Brake Systems  $10.6    18.1%  $11.2    20.6%
                     
Total  $58.7    100.0%  $54.5    100.0%

 

Net sales were $58,702,505 and $54,488,640 for the three months ended September 30, 2014 and 2013, respectively, an increase of $4.2 million or 7.7%. The increase was due to the increased sales of Commercial Vehicle Brake Systems to China market and after market.

 

The sales from Commercial Vehicle Brake Systems increased by $4.8 million or 11.1%, to $48.1 million for the third fiscal quarter of 2014, compared to $43.3 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.

 

The sales from Passenger Vehicle Brake Systems decreased by $0.6 million or 5.4%, to $10.6 million for the third fiscal quarter of 2014, compared to $11.2 million for the same period of 2013. The decrease was mainly due to the adjustment of our customer structure in the third fiscal quarter of 2014, namely reducing or suspending sales to customers who have long term overdue payment or who makes relatively small amount of orders.

 

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

 

19
 

 

   Three
Months
       Three
Months
         
   Ended   Percent   Ended   Percent     
   September
30, 2014
   of
Total Sales
   September
30, 2013
   of
Total Sales
   Percentage
Change
 
   (U.S. dollars in million)     
China OEM market  $24.0    40.9%  $22.3    40.8%   7.8%
China Aftermarket  $17.2    29.3%  $13.1    24.1%   31.5%
International market  $17.5    29.8%  $19.1    35.1%   -8.7%
                          
Total  $58.7    100.0%  $54.5    100.0%   7.7%

 

Our sales to the Chinese OEM market increased by 7.8% from the third fiscal quarter of 2013, to $24.0 million. This increase is mainly a result of continued market demand of commercial vehicles that meet the Chinese National III standard for vehicles in the third fiscal quarter of 2014..

 

Our sales to the China aftermarket increased by $4.1 million or 31.5%, to $17.2 million for the third fiscal quarter of 2014, compared to $13.1 million for the same period of 2013. The reasons of the increase are: (1) Our large portfolio of products for the aftermarket provides us with a competitive advantage, enabling us to further penetrate and capture additional share in this segment; (2) Our new products with advanced features have increased our ability to service a wider range of vehicles coming off warranty, driving unit growth in both the OEM and aftermarket in the third fiscal quarter of 2014. (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 decreased by $1.6 million or 8.7%, to $17.5 million for the third fiscal quarter of 2014, as compared to $19.1 million for the same period of 2013. The decrease was mainly due to the weak economy in Europe and the crisis in Ukraine.

 

Cost of Sales and Gross Profit

 

Cost of sales for the three months ended September 30, 2014 were $43,240,746, an increase of $4.2 million or 10.7% from $39,075,431 for the three months ended September 30, 2013. Our gross profit increased by 0.3% from $15,413,209 for the period of 2013 to $15,461,759 for the three months ended September 30, 2014.

 

Gross margin decreased to 26.3% from 28.3% for the three months ended September 30, 2014 compared with the same period of 2013. One of the reasons for the decrease is that, to strengthen our competitiveness and increase our market share, we started the product promotion in the third fiscal quarter of 2014. The increased labor cost also decreased our gross margin for the three months ended September 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 three months ended September 30, 2014 were $35.4 million, an increase of $4.4 million or 14.1% from $31.0 million for the same period last year. The gross profit from Commercial Vehicle Brake Systems increased by 3.4% from $12.2 million for three months ended September 30, 2013 to $12.7 million for the three months ended September 30, 2014. Gross margin from Commercial Vehicle Brake Systems decreased to 26.3% from 28.3% for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. This decrease is resulted from product promotion and increased labor cost as explained above.

 

20
 

 

Cost of sales from Passenger Vehicle Brake Systems for the three months ended September 30, 2014 were $7.8 million, an decrease of $0.2 million or 2.7% from $8.0 million for the three month ended September 30, 2013. The gross profit from Passenger Vehicle Brake Systems decreased by 11.8% from $3.2 million for the three month ended September 30, 2013 to $2.8 million for the three month ended September 30, 2014. Gross margin from Passenger Vehicle Brake Systems decreased to 26.3% from 28.3% for the three months ended September 30, 2014, as compared with the same period in 2013. This decrease is resulted from product promotion and increased labor cost as explained above.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were $5,871,463 for the three months ended September 30, 2014, as compared to $5,277,020 for the same period of 2013, an increase of $0.6 million or 11.3%.

 

The increase was mainly due to increased freight expense and packaging expenses. As a percentage of sales revenue, selling expenses increased to 10.0% for the three months ended September 30, 2014, as compared to 9.7% for the same period in 2013.

 

General and Administrative Expenses

 

General and administrative expenses were $3,759,307 for the three months ended September 30, 2014, as compared to $3,696,715 for the same period of 2013, an increase of $62,592 or 1.7%. The increase was mainly due to increases in labor expenses and administrative expenses. As a percentage of sales revenue, general and administrative expenses decreased to 6.4% for the three months ended September 30, 2014, as compared to 6.8% 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 September 30, 2014, research and development expenses were $2,242,620, as compared to $2,384,902 for the same period of 2013, a decrease of $142,282.

 

Other Operating Income

 

Other operating income was $545,752 for the three months ended September 30, 2014, as compared to $444,791 for the three months ended September 30, 2013, an increase of $100,961. The increase was mainly due to the increase in sales of raw material scraps for the three months ended September 30, 2014.

 

Depreciation and Amortization

 

Depreciation and amortization expense decreased to $1,865,486 for the three months ended September 30, 2014, compared with that of $1,992,254 for the same period of 2013, a decrease of $126,768. The decrease in depreciation and amortization expense was primarily due to the fact that more production equipment was depreciated to residual value and stopped being further depreciated for the three months ended September 30, 2014.

 

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 September 30, 2014, decreased by $136,136 to $634,282 from $770,418 for the same period of 2013, which was mainly due to decreased interest expense related bank loans and discounted bank and trade acceptance notes.

 

21
 

 

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 $391,988 for the three months ended September 30, 2014, as compared to $332,027 for the three months ended September 30, 2013.

 

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 $262,813 and $423,087 for the third fiscal quarter ended September 30, 2014 and 2013, respectively.

 

Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the fiscal quarter ended September 30, 2014, decreased by $409,685, to $2,900,935 from $3,310,620 for the fiscal quarter ended September 30, 2013 due to the increase in cost of sales and decrease of the gross margin. Earnings per share (“EPS”), both basic and diluted, for the fiscal quarter ended September 30, 2014 and 2013, were $0.15 and $0.17.

 

Results of operations for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013.

 

Sales

 

   Nine Months Ended   Nine Months Ended 
   September 30, 2014   September 30, 2013 
   (U.S.  dollars in
millions)
 
Commercial Vehicle Brake Systems  $142.0    81.4%  $124.2    81.0%
Passenger Vehicle Brake Systems  $32.4    18.6%  $29.1    19.0%
                     
Total  $174.4    100.0%  $153.3    100.0%

 

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Net sales were $174,419,540 and $153,317,804 for the nine months ended September 30, 2014 and 2013, respectively, an increase of $21.1 million or 13.8%. The increase was due to the increased sales to China market and after market.

 

The sales from Commercial Vehicle Brake Systems increased by $17.8 million or 14.3%, to $142.0 million for the nine months ended September 30, 2014, compared to $124.2 million for the same period of 2013. Due to the recovery of the commercial vehicle market during the nine months ended September 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 $3.3 million or 11.6%, to $32.4 million for the nine months ended September 30, 2014, compared to $29.1 million for the same period of 2013. The increase was mainly due to the adjustment of our customer structure in the nine months ended September 30, 2014, namely reducing or suspending sales to customers who have long term overdue payment or who makes relatively small amount of orders.

 

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

 

   Nine Months   Percent   Nine Months   Percent     
   Ended   of   Ended   of     
   September 30,
2014
   Total
Sales
   September
30, 2013
   Total
Sales
   Percentage
Change
 
   (U.S. dollars in million)     
China OEM market  $84.5    48.5%  $75.7    49.3%   11.6%
China Aftermarket  $43.1    24.7%  $35.1    22.9%   22.8%
International market  $46.8    26.8%  $42.5    27.8%   9.9%
Total  $174.4    100.0%  $153.3    100.0%   13.8%

 

The favorable Chinese vehicle license plate policies toward the National III standard vehicles are set to expire by January 1, 2015, which resulted in the higher demand for commercial vehicles in China for the nine months ended September 30, 2014. As a result, our sales to the Chinese OEM market increased by 11.6% from the nine months ended September 30, 2014, to $84.5 million.

 

Our sales to the China aftermarket increased by $8.0 million or 22.8%, to $43.1 million for the nine months ended September 30, 2014, compared to $35.1 million for the same period of 2013. Our large portfolio of products for the aftermarket provides us with a competitive advantage, enabling us to further penetrate and capture additional share in this segment. Our new products with advanced features have increased our ability to service a wider range of vehicles coming off warranty, driving unit growth in both the OEM and aftermarket during the nine months ended September 30, 2014. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets. Accelerated urbanization and the Chinese government’s increased support for public transportation favor our expansion in the bus aftermarket.

 

Our export sales increased by $4.3 million or 9.9%, to $46.8 million for the nine months ended September 30, 2014, as compared to $42.5 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.

 

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Cost of Sales and Gross Profit

 

Cost of sales for the nine months ended September 30, 2014 were $125,056,960, an increase of $16.2 million or 14.9% from $108,858,673 for the same period last year. Our gross profit increased by 11.0% from $44,459,131 for the nine months ended September 30, 2013 to $49,362,580 for the same period of 2014.

 

Gross margin decreased to 28.3% from 29.0% for the nine months ended September 30, 2014, as compared with the same period of 2013. One of the reasons for the decrease is that, to strengthen our competitiveness and increase our market share, we started the product promotion in the nine month period ended September 30, 2014. The increased labor cost also decreased our gross margin for the nine month period ended September 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 nine months ended September 30, 2014 were $101.8 million, an increase of $13.6 million or 15.4% from $88.2 million for the same period of 2013. The gross profit from Commercial Vehicle Brake Systems increased by 11.5% from $36.0 million for the nine months ended September 30, 2013 to $40.2 for the same period of 2014. Gross margin from Commercial Vehicle Brake Systems decreased to 28.3% from 29.0% for the nine months ended September 30, 2014 compared with the same period of 2013.

 

Cost of sales from Passenger Vehicle Brake Systems for the nine months ended September 30, 2014 were $23.3 million, an increase of $2.6 million or 12.7% from $20.6 million for the same period of 2013. The gross profit from Passenger Vehicle Brake Systems increased by 8.9% from $8.4 million for the nine months ended September 30, 2013 to $9.2 for the same period of 2014. Gross margin from Passenger Vehicle Brake Systems decreased to 28.3% from 29.0% for the nine months ended September 30, 2014, as compared with the same period in 2013.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were $18,050,068 for the nine months ended September 30, 2014, as compared to $14,596,863 for the same period of 2013, an increase of $3,453,205 or 23.7%.

 

The increase was mainly due to increased freight expense and packaging expenses. As a percentage of sales revenue, selling expenses increased to 10.3% for the nine months ended September 30, 2014, as compared to 9.5% for the same period in 2013.

 

General and Administrative Expenses

 

General and administrative expenses were $12,786,335 for the nine months ended September 30, 2014, as compared to $13,079,992 for the same period of 2013, a decrease of $0.3 million or 2.2%.

 

The decrease was mainly due to the cost control measures implemented during this quarter. As a percentage of sales revenue, general and administrative expenses decreased to 7.3% for the nine months ended September 30, 2014, as compared to 8.5% 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 nine months ended September 30, 2014, research and development expenses were $5,934,377, as compared to $5,392,513 for the same period of 2013, an increase of $0.5 million.

 

Other Operating Income

 

Other operating income was $1,471,014 for the nine months ended September 30, 2014, as compared to $1,280,683 for the nine months ended September 30, 2013, an increase of $190,331. The increase was mainly due to an increase in sales of raw material scrap for the nine months ended September 30, 2014.

 

Depreciation and Amortization

 

Depreciation and amortization expenses decreased to $5,597,867 for the nine months ended September 30, 2014, compared with that of $5,617,369 for the same period of 2013, a decrease of $19,502. The decrease in depreciation and amortization expense was primarily due to the fact that more production equipment was depreciated to residual value and stopped being further depreciated for the nine months ended September 30, 2014.

 

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 nine months ended September 30, 2014, decreased by $435,533 to $1,773,223 from $2,208,756 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 $1,556,433 for the nine months ended September 30, 2014, as compared to $1,040,215 for the nine months ended September 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% non-controlling interest in SIH. Each of the noncontrolling interest is held by our Joint Venture partners. Net income attributable to noncontrolling interest in subsidiaries amounted to $1,003,631 and $1,075,525 for the nine months ended September 30, 2014 and 2013, respectively.

 

25
 

 

Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the nine months ended September 30, 2014, increased by $1,224,921, to $9,803,712 from $8,578,791 for the nine months ended September 30, 2013, due to increased net income, which was caused by increased sales. The main factors contributing to our sales increase in the nine months ended September 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 nine months ended September 30, 2014 and 2013, were $0.51 and $0.44, respectively.

 

FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

As of September 30, 2014, the Company had cash and cash equivalents of $37,902,347, as compared to cash and cash equivalents of $28,241,983 as of December 31, 2013. The Company had working capital of $158,654,709 at September 30, 2014, as compared to working capital of $144,658,883 at December 31, 2013, reflecting current ratios of 4.12:1 and 4.13:1, respectively.

 

OPERATING - Net cash provided by operating activities was $11,407,243 for nine months ended September 30, 2014, an increase of $10,399,249, as compared with $1,067,994 of net cash provided by operating activities in the same period in 2013. Such increase was primarily due to the increased cash inflow resulted by changes in bank acceptance notes from customers.

 

INVESTING - During the nine months ended September 30, 2014, the Company expended net cash of $2,937,232 in investing activities mainly for acquisition of new equipment to support the growth of the business. For the nine months ended September 30, 2013, the Company expended net cash of $3,342,250 in investing activities.

 

FINANCING - During the nine month ended September 30, 2014, the cash provided by financing activities was $682,594. Cash used in financing activities was $7,387,477 for the nine months ended September 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 September 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 that the government will oppose the Company’s right to use the land and related building.

 

c)      The Company has reserved tax payables in the amount of RMB 4,560,000 (approximately $724,580) on its consolidated balance sheets under the line item “accrued expenses” as if no reduction or exemption of tax is approved. This amount was determined based on a 3% tax rate on the consideration paid for the land use right in the transaction, which the Company considered as the most probable amount of tax liability. This amount also represented the maximum amount of tax the Company expects to pay if the negotiation with the local government ultimately is not successful.

 

ITEM 3. CONTRACTUAL OBLIGATIONS

 

As of September 30, 2014, we had no material changes outside the ordinary course of business in our contractual obligations

 

ITEM 4. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable.

 

ITEM 5. 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 September 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.

 

27
 

 

Changes in Internal Control over Financial Reporting:

 

There were no changes in the Company’s internal control over financial reporting during the nine months ended September 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.

 

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 (approved May 27, 2010). (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 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, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated : November 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)

 

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