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EX-31.1 - EXHIBIT 31.1 - SORL Auto Parts Incv424259_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - SORL Auto Parts Incv424259_ex31-2.htm
EX-32 - EXHIBIT 32 - SORL Auto Parts Incv424259_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, 2015

 

¨ 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 16, 2015 there were 19,304,921 shares of common stock outstanding

 

 

 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Quarter Ended September 30, 2015

 

INDEX

 

    Page
PART I. FINANCIAL INFORMATION (Unaudited) 1
     
Item 1. Financial Statements: 1
     
  Consolidated Balance Sheets as of September 30, 2015 (Unaudited) and December 31, 2014 2
     
  Consolidated Statements of Income and Comprehensive Income for the Three and Nine Months Ended September 30, 2015 and 2014 (Unaudited) 3
     
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014 (Unaudited) 4
     
  Consolidated Statements of Changes in Equity for the Nine Months Ended September 30, 2015 (Unaudited) 5
     
  Notes to the Consolidated Financial Statements (Unaudited) 6
     
Item 2. Management’s Discussion and Analysis or Financial Condition and Results of Operations 18
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
     
Item 4. Controls and Procedures 26
     
PART II. OTHER INFORMATION 26
     
Item 1. Legal Proceedings. 26
     
Item 1A. Risk Factors. 26
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 26
     
Item 3. Defaults Upon Senior Securities. 26
     
Item 4. Mine Safety Disclosures. 26
     
Item 5. Other Information. 26
     
Item 6. Exhibits 27
     
SIGNATURES 28

 

 1 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Balance Sheets

September 30, 2015 and December 31, 2014

 

   September 30, 2015   December 31, 2014 
   (Unaudited)     
Assets          
Current Assets          
Cash and cash equivalents  US$5,742,833   US$14,009,597 
Accounts receivable, net   66,155,023    68,171,387 
Bank acceptance notes from customers   11,479,383    17,626,704 
Short term investments   87,021,944    34,838,757 
Inventories   68,082,837    84,186,766 
Prepayments, including US$0 and US$83,206 due from related parties at September 30, 2015 and December 31, 2014, respectively   4,928,389    4,663,002 
Current portion of prepaid capital lease interest   139,433    282,280 
Other current assets   1,236,503    1,282,182 
Deferred tax assets   3,579,607    1,868,371 
Total Current Assets   248,365,952    226,929,046 
           
Property, plant and equipment, net   39,231,690    43,550,927 
Land use rights, net   13,598,612    14,421,729 
Intangible assets, net   27,319    37,661 
Security deposits on lease agreement   1,796,578    1,867,719 
Non-current portion of prepaid capital lease interest   7,339    99,180 
Total Non-Current Assets   54,661,538    59,977,216 
Total Assets  US$303,027,490   US$286,906,262 
           
Liabilities and Equity          
Current Liabilities          
Accounts payable and bank acceptance notes to vendors, including US$2,067,365 and US$136,609 due to related parties at September 30, 2015 and December 31, 2014, respectively  US$14,978,233   US$13,867,316 
Deposit received from customers   26,299,643    19,045,172 
Short term bank loans   22,042,744    9,539,476 
Income tax payable   1,474,677    1,101,103 
Accrued expenses   11,843,133    13,561,163 
Current portion of capital lease obligations   3,593,156    3,735,438 
Other current liabilities, including US$117,067 and US$17,681 due to related parties at September 30, 2015 and December 31, 2014, respectively   2,403,786    2,131,527 
Total Current Liabilities   82,635,372    62,981,195 
           
Non-Current Liabilities          
Non-current portion of capital lease obligations   898,289    3,735,437 
Total Non-Current Liabilities   898,289    3,735,437 
Total Liabilities   83,533,661    66,716,632 
           
Equity          
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of September 30, 2015 and December 31, 2014   -    - 
Common stock - US$0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of September 30, 2015 and December 31, 2014   38,609    38,609 
Additional paid-in capital   42,199,014    42,199,014 
Reserves   12,767,531    12,019,532 
Accumulated other comprehensive income   19,620,317    27,516,206 
Retained earnings   123,547,436    116,935,053 
Total SORL Auto Parts, Inc. Stockholders' Equity   198,172,907    198,708,414 
Non-controlling Interest In Subsidiaries   21,320,922    21,481,216 
Total Equity   219,493,829    220,189,630 
Total Liabilities and Equity  US$303,027,490   US$286,906,262 

 

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

 

 2 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Income and Comprehensive Income

For The Three and Nine Months Ended September 30, 2015 and 2014 (Unaudited)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2015   2014   2015   2014 
                 
Net sales  US$50,323,832   US$58,702,505   US$161,796,676   US$174,419,540 
Sales to related parties   2,171,824    534,195    4,241,472    2,169,778 
Cost of sales   36,622,501    43,240,746    117,835,825    125,056,960 
Gross profit   13,701,331    15,461,759    43,960,851    49,362,580 
                     
Expenses:                    
Selling and distribution expenses   4,813,129    5,871,463    15,250,216    18,050,068 
General and administrative expenses   5,634,735    3,759,307    15,784,330    12,786,335 
Research and development expenses   2,261,665    2,242,620    5,831,756    5,934,377 
Total operating expenses   12,709,529    11,873,390    36,866,302    36,770,780 
                     
Other operating income   463,198    545,752    1,532,006    1,471,014 
                     
Income from operations   1,455,000    4,134,121    8,626,555    14,062,814 
                     
Interest income   162,770    26,204    683,561    86,839 
Other income   1,825,177    100,534    2,616,586    352,130 
Interest expenses   (395,121)   (403,482)   (804,321)   (1,126,212)
Other expenses   (198,828)   (301,641)   (807,407)   (1,011,795)
                     
Income before provision for income taxes   2,848,998    3,555,736    10,314,974    12,363,776 
                     
Provision for income taxes   427,905    391,988    2,220,327    1,556,433 
                     
Net income  US$2,421,093   US$3,163,748   US$8,094,647   US$10,807,343 
                     
Net income attributable to non-controlling interest in subsidiaries   373,067    262,813    734,265    1,003,631 
                     
Net income attributable to common stockholders  US$2,048,026   US$2,900,935   US$7,360,382   US$9,803,712 
                     
Comprehensive income:                    
                     
Net income  US$2,421,093   US$3,163,748   US$8,094,647   US$10,807,343 
Foreign currency translation adjustments   (8,972,031)   (108,081)   (8,790,448)   4,224,775 
Comprehensive income (loss)   (6,550,938)   3,055,667    (695,801)   15,032,118 
Comprehensive income (loss) attributable to non-controlling interest in subsidiaries   (524,189)   193,652    (160,294)   1,336,705 
Comprehensive income (loss) attributable to common stockholders  US$(6,026,749)  US$2,862,015   US$(535,507)  US$13,695,413 
                     
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$0.11   US$0.15   US$0.38   US$0.51 
                     
EPS - diluted  US$0.11   US$0.15   US$0.38   US$0.51 

 

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

 

 3 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For The Nine Months Ended September 30, 2015 and 2014 (Unaudited)

 

   Nine Months Ended September 30, 
   2015   2014 
         
Cash Flows From Operating Activities          
Net Income  US$8,094,647   US$10,807,343 
Adjustments to reconcile net income to net cash from operating activities          
           
Allowance for doubtful accounts   6,817,520    1,697,068 
Depreciation and amortization   5,765,138    5,597,867 
Deferred income tax   (1,838,158)   (405,594)
(Gain) or loss on disposal of property and equipment   (44,486)   35,655 
Changes in assets and liabilities          
Accounts receivable   (7,700,931)   (7,790,502)
Bank acceptance notes from customers   5,653,836    6,153,022 
Other currents assets   (8,665)   755,849 
Inventories   13,369,960    (3,305,061)
Prepayments   (536,193)   (2,716,212)
Prepaid capital lease interest   227,367    362,790 
Accounts payable and bank acceptance notes to vendors   1,381,794    (4,895,398)
Income tax payable   434,069    (26,461)
Deposits received from customers   8,243,799    1,506,420 
Other current liabilities and accrued expenses   (874,410)   3,630,457 
Net Cash Flows Provided By Operating Activities   38,985,287    11,407,243 
           
Cash Flows From Investing Activities          
Change in short term investments   (54,985,353)   - 
Acquisition of property and equipment   (2,440,511)   (2,994,571)
Proceeds of disposal of property and equipment   48,956    57,339 
Net Cash Flows (Used In) Investing Activities   (57,376,908)   (2,937,232)
           
Cash Flows From Financing Activities          
Proceeds from bank loans   32,886,768    28,383,953 
Repayment of bank loans   (19,626,376)   (24,924,952)
Repayment of capital lease   (2,780,713)   (2,776,407)
Net Cash Flows Provided By Financing Activities   10,479,679    682,594 
           
Effects on changes in foreign exchange rate   (354,822)   507,759 
           
Net change in cash and cash equivalents   (8,266,764)   9,660,364 
           
Cash and cash equivalents- beginning of the period   14,009,597    28,241,983 
           
Cash and cash equivalents - end of the period  US$5,742,833   US$37,902,347 
           
Supplemental Cash Flow Disclosures          
Interest paid  US$815,839   US$1,126,215 
Income taxes paid  US$3,624,319   US$1,983,823 

 

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

 

 4 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Equity

For the Nine Months Ended September 30, 2015 (Unaudited)

 

   Number of   Common  

Additional

Paid-in

       Retained  

Accumulated

Other

Comprehensive

  

Total SORL Auto

Parts, Inc.

   Non-controlling     
   Share   Stock   Capital   Reserves   Earnings   Income   Stockholders' Equity   Interest   Total Equity 
Beginning Balance - January 1, 2015   19,304,921   US$38,609   US$42,199,014   US$12,019,532   US$116,935,053   US$27,516,206   US$198,708,414   US$21,481,216   US$220,189,630 
                                              
Net income   -    -    -    -    7,360,382    -    7,360,382    734,265    8,094,647 
                                              
Foreign currency translation adjustment   -    -    -    -    -    (7,895,889)   (7,895,889)   (894,559)   (8,790,448)
                                              
Transfer to reserve   -    -    -    747,999    (747,999)   -    -    -    - 
                                              
Ending Balance - September 30, 2015   19,304,921   US$38,609   US$42,199,014   US$12,767,531   US$123,547,436   US$19,620,317   US$198,172,907   US$21,320,922   US$219,493,829 

 

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

 

 5 

 

 

SORL Auto Parts, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

(Unaudited)

 

NOTE A - DESCRIPTION OF BUSINESS

 

SORL Auto Parts, Inc. (together with its subsidiaries, “we,” “us,” “our” or the “Company” or “SORL”), a Delaware corporation incorporated on March 24, 1982, 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. 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 SORL International Holding, Ltd., or SIH. SORL holds a 60% interest in SIH, 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 the Asia-Pacific region and creating a larger footprint in Europe, the Middle East and Africa with a goal 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 US$10.00 per share pursuant to a registered direct offering. This transaction provided net proceeds of approximately US$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 Ruili Group. 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 Ruili Group other than those in the segment of Ruili Group’s business described above. The Company recorded the excess of consideration over the carrying value of net assets received as a decrease in the additional paid-in capital of the Company.

 

The Company accounted for the acquisition 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, together with his wife and brother, owns more than 50% of the outstanding common stock of SORL. As a result, the Company accounted for the acquisition using the historical costs of the financial statements of the Ruili Group. 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 asset purchase was deemed to be the acquisition of a business.

 

 6 

 

 

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, 2014 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, 2014. 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, 2014, 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, short term investments, 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.

 

 7 

 

 

e. COST OF SALES

 

Cost of sales consists primarily of materials costs, applicable local government levies, freight charges, purchasing and receiving costs, inspection costs, employee compensation, depreciation and related costs, which are directly attributable to production. Write-down of inventories to lower of cost or market is also recorded in cost of sales, if any.

 

f. 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 stockholders’ equity accounts are translated at the 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. During the three and nine months ended September 30, 2015, the Company had US$1,268,968 and US$1,346,439 transaction gain, respectively, which was included in other income. During the three and nine months ended September 30, 2014, the Company had US$108,198 and US$95,924 transaction loss, respectively, which was included in other expenses.

 

g. 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 ACCOUNTING PRONOUNCEMENTS

 

In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs”. The amendments in the ASU are intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The amendments in this ASU are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. The Company is currently in the process of evaluating the impact of the adoption on its consolidated financial statements.

 

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory”. The amendments in ASU 2015-11 require an entity to measure in scope inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using last-in, first-out (LIFO) or the retail inventory method. The amendments do not apply to inventory that is measured using LIFO or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. A reporting entity should apply the amendments prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently in the process of evaluation the impact of adoption on its consolidated financial statements.

 

 8 

 

 

In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date”. The amendments in ASU 2015-14 defer the effective date of ASU 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting 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 2015, the FASB issued ASU No. 2015-15, “Interest-Imputation of Interest: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements”, which addresses line-of-credit arrangements that were omitted from ASU 2015-03 (see above). This Update states that the SEC staff would not object to an entity deferring and presenting debt issuance costs related to a line-of-credit arrangement as an asset and subsequently amortizing those costs ratably over the term of the arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. We do not believe the adoption of this guidance will have a significant impact on our consolidated financial statements.

 

In September 2015, the FASB issued ASU 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments”. The amendments in ASU 2015-16 require that an acquirer recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the estimated amounts, calculated as if the accounting had been completed at the acquisition date. The amendments also require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the estimated amounts had been recognized as of the acquisition date. The adoption of this standard is not expected to have a material impact on the Company’s financial position and results of operations.

 

NOTE D - RELATED PARTY TRANSACTIONS

 

The Company continues to purchase packaging materials from the Ruili Group. The Ruili Group is the minority stockholder of Joint Venture and is collectively controlled by Mr. Xiao Ping Zhang, his wife Ms. Shu Ping Chi, and his brother Mr. Xiao Feng Zhang. In addition, the Company purchases from two other related parties, Guangzhou Kormee Automotive Electronic Control 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, 2015 and September 30, 2014:

 

 9 

 

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
PURCHASES FROM:                    
Guangzhou Kormee Automotive Electronic Control Co., Ltd.  US$ 957,017   US$178,095   US$1,331,566   US$1,650,115 
Ruian Kormee Vehicle Brake Co., Ltd.   202,924    326,002    680,983    1,095,959 
Ruili Group Co., Ltd.   751,044    862,037    2,379,870    2,905,090 
Total Purchases  US$  1,910,985   US$ 1,366,134   US$ 4,392,419   US$5,651,164 
                     
SALES TO:                    
Guangzhou Kormee Automotive Electronic Control Co., Ltd.  US$ 145,564   US$ 153,236   US$ 408,334   US$ 1,127,947 
Ruian Kormee Vehicle Brake Co., Ltd.   2,327    12,743    30,077    68,482 
Ruili Group Co., Ltd.   2,171,824    368,216    4,241,472    973,349 
Total Sales  US$2,319,715   US$534,195   US$4,679,883   US$ 2,169,778 

 

During the three and nine months ended September 30, 2015, for the sales mentioned above, the sales to Guangzhou Kormee and Ruian Kormee were sales of scrap materials and were included in other operating income in the consolidated statements of income and comprehensive income. The sales to Ruili Group were included in sales in the consolidated statements of income and comprehensive income.

 

   September 30,
 2015
   December 31,
 2014
 
PREPAYMENTS          
Ruian Kormee Vehicle Brake Co., Ltd.  US$   US$83,206 
Total  US$   US$83,206 
           
ACCOUNTS PAYABLE          
Ruian Kormee Vehicle Brake Co., Ltd.  US$349,936   US$ 
Guangzhou Kormee Automotive Electronic Control Co., Ltd.   718,194    59,011 
Ruili Group Co., Ltd.   999,235    77,598 
Total  US$2,067,365   US$136,609 
           
OTHER PAYABLES          
MGR Hong Kong Limited  US$1,052   US$17,681 
Ruili Group Co., Ltd.   116,015     
Total  US$117,067   US$17,681 

 

 10 

 

 

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

 

 In addition, the Company provided a guarantee for the credit line granted to Ruili Group by the Bank of Ningbo in the amount of RMB 108,000,000 (approximately US$17,182,404) for the period from September 26, 2013 to September 25, 2014, which was renewed in 2014 for a term from August 22, 2014 to August 21, 2015. The Company also provides a guarantee for Ruili Group related to the credit line granted by China Zheshang Bank in the amount of RMB 146,960,000 (approximately US$24,016,996) for the period from December 9, 2014 to December 9, 2015.

 

NOTE E - ACCOUNTS RECEIVABLE

 

Accounts receivable, net consisted of the following:

 

   September 30,
2015
   December 31, 
2014
 
Accounts receivable  US$78,948,090   US$74,646,974 
Less: allowance for doubtful accounts   (12,793,067)   (6,475,587)
           
Account receivable, net  US$66,155,023   US$68,171,387 

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the nine months ended September 30, 2015. The changes in the allowance for doubtful accounts at September 30, 2015 and December 31, 2014 are summarized as follows:

 

   September 30, 2015   December 31, 2014 
Beginning balance  US$ 6,475,587   US$3,813,415 
           
Add: Increase to allowance   6,317,480    2,662,172 
           
Ending balance  US$12,793,067   US$ 6,475,587 

 

NOTE F - INVENTORIES

 

At September 30, 2015 and December 31, 2014, inventories consisted of the following:

 

   September 30,
2015
   December 31,
2014
 
Raw materials  US$6,291,726   US$11,934,720 
Work in process   30,838,503    30,020,125 
Finished goods   31,120,889    42,400,202 
Less: Write-down of inventories   (168,281)   (168,281)
Total inventories  US$68,082,837   US$84,186,766 

 

 11 

 

 

NOTE G - PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following, at September 30, 2015 and December 31, 2014:

 

   September 30, 2015   December 31, 2014 
Machinery  US$50,979,751   US$51,619,990 
Molds   1,371,676    1,425,992 
Office equipment   2,135,896    2,257,208 
Vehicles   2,024,271    2,040,061 
Buildings   8,804,325    9,152,959 
Machinery held under capital lease   29,012,601    29,012,601 
Leasehold improvements   543,048    562,521 
Sub-Total   94,871,568    96,071,332 
           
Less: Accumulated depreciation   (55,639,878)   (52,520,405)
           
Property, plant and equipment, net  US$ 39,231,690   US$ 43,550,927 

 

Depreciation expense charged to operations was US$5,421,040 and US$5,247,145 for the nine months ended September 30, 2015 and September 30, 2014, respectively.

 

NOTE H - DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES

 

Deferred tax assets consisted of the following as of September 30, 2015 and December 31, 2014:

 

   September 30, 2015   December 31, 2014 
Deferred tax assets - current          
Allowance for doubtful accounts  US$2,607,100   US$990,496 
Revenue (net of cost)   37,410     
Unpaid accrued expenses   82,904    180,392 
Warranty   852,193    848,566 
Deferred tax assets   3,579,607    2,019,454 
Valuation allowance        
Net deferred tax assets - current  US$3,579,607   US$2,019,454 
           
Deferred tax liabilities - current          
Revenue (net of cost)  US$   US$ 151,083 
Deferred tax liabilities - current       151,083 
           
Net deferred tax assets - current  US$ 3,579,607   US$  1,868,371 

 

 12 

 

 

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 United States 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, 2015 and December 31, 2014:

 

   September 30,
2015
   December 31,
2014
 
Secured  US$  22,042,744   US$9,539,476 

 

The Company obtained those short term loans from Bank of China, Bank of Ningbo, China Construction Bank, OCBC Bank and Agricultural Bank of China, respectively, to finance general working capital as well as new equipment acquisition. Interest rate for the loans ranged from 1.33% to 5.35% per annum. The maturity dates of the loans ranged from October 16, 2015 to May 14, 2016. As of September 30, 2015 and December 31, 2014, the Company’s accounts receivables of US$14,463,567 and US$12,328,735, respectively, were pledged as collateral under loan arrangements. For the three months ended September 30, 2015 and 2014, the interest expenses for short-term bank loans were US$213,797 and US$67,454, respectively. For the nine months ended September 30, 2015 and 2014, the interest expenses for short-term bank loans were US$375,518 and US$434,044, respectively.

 

Corporate or personal guarantees:
US$3,608,512      Guaranteed by the Ruili Group, a related party;
US$15,551,000   Guaranteed by the Ruili Group, a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both principal stockholders.
US$2,883,232   Guaranteed by the Ruili Group, a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both principal stockholders and Jia Rui Zhang, the daughter of Mr. Xiao Ping Zhang and Ms. Shu Ping Chi.

 

NOTE J –CAPITAL LEASE OBLIGATIONS

 

   September 30, 2015   December 31, 2014 
         
Total capital lease obligations  US$4,491,445   US$7,470,875 
Less: Current portion   (3,593,156)   (3,735,438)
Non-current portion  US$898,289   US$  3,735,437 

 

 13 

 

 

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 its financing expenses, the Company entered into a new leasing agreement with International Far Eastern Leasing Co., Ltd. in December 2012 and terminated the original agreement. The lease inception date of the new lease agreement is January 4, 2013 and the termination date was January 4, 2017. The duration of the new agreement was 48 months with an interest rate of 6.4% per annum and was secured with the Company’s equipment in the original cost of US$28,396,853. The capital lease obligation obtained by the Company was 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 1,904,761.9 (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.

 

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.

 

In 2009, the Company was awarded the “High-Tech Enterprise” certificate by the Chinese government. The High-Tech Enterprise certificate was valid for three years and provided the Company with a reduced tax rate of 15%. The Company passed the re-assessment of the “High-Tech Enterprise” designation by the government in 2012 and continued to be taxed at a 15% rate in 2012 through 2014. Upon the expiration of the “High-Tech Enterprise” certificate in 2015, the Company is undergoing the re-assessment of the certificate by the government and is currently subject to a tax rate of 25%.

 

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 2015 and 2014 is as follows:

 

   Nine Months Ended
September 30, 2015
   Nine Months Ended
September 30, 2014
 
U.S. statutory income tax rate   35.00%   35.00%
Valuation allowance recognized with respect to the loss in the U.S. company   -35.00%   -35.00%
HK statutory income tax rate   16.50%   16.50%
Valuation allowance recognized with respect to the loss in the HK company   -16.50%   -16.50%
China statutory income tax rate   25.00%   25.00%
Effects of income tax exemptions and reliefs   -    -10.00%
Effects of additional deduction allowed for Research and Development expenses   -7.07%   -3.60%
Other items   3.60%   1.19%
           
Effective tax rate   21.53%   12.59%

 

 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, 2015. 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, 2015, 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, 2015 and 2014, respectively, are summarized as follows:

 

  

Nine Months Ended

September 30, 2015

  

Nine Months Ended

September 30, 2014

 
         
Current  US$4,058,485   US$1,962,026 
Deferred   (1,838,158)   (405,593)
           
Total  US$2,220,327   US$1,556,433 

 

ASC 740-10 requires recognition and measurement of uncertain income tax positions using a “more-likely-than-not” approach. The management evaluated the Company’s tax positions and considered that no provision for uncertainty in income taxes was necessary as of September 30, 2015 and December 31, 2014.

 

NOTE L – NON-CONTROLLING INTEREST IN SUBSIDIARIES

 

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 US$734,265 and US$1,003,631 for the nine months ended September 30, 2015 and 2014, respectively.

 

  

Nine Months Ended

September 30, 2015

  

Nine Months Ended

September 30, 2014

 
10% non-controlling interest in Ruian  US$831,112   US$1,101,336 
40% non-controlling interest in SIH   (96,847)   (97,705)
           
Total  US$734,265   US$1,003,631 

 

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 newly 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 US$1,245,477 and US$1,221,583 for the nine months ended September 30, 2015 and 2014, respectively.

 

NOTE N - WARRANTY CLAIMS

 

Warranty claims were US$1,515,278 and US$1,717,235 for the nine months ended September 30, 2015 and September 30, 2014, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The change of accrued warranty expenses for the nine months ended September 30, 2015 was as follows:

 

Beginning balance at January 1, 2015  US$5,657,106 
Aggregate increase for new warranties issued during current period   1,515,278 
Aggregate reduction for payments made   (1,586,962)
Ending balance at September 30, 2015:  US$5,585,422 

 

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 expanded our product offerings 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, 
   2015   2014 
         
NET SALES TO EXTERNAL CUSTOMERS          
Commercial Vehicle Brake Systems  US$130,397,720   US$141,967,713 
Passenger Vehicle Brake Systems   31,398,956    32,451,827 
Net sales  US$161,796,676   US$174,419,540 
INTERSEGMENT SALES          
Commercial Vehicle Brake Systems  US$   US$ 
Passenger Vehicle Brake Systems        
Intersegment sales  US$   US$ 
GROSS PROFIT          
Commercial Vehicle Brake Systems  US$35,136,082   US$39,096,457 
Passenger Vehicle Brake Systems   8,824,769    10,266,123 
Gross profit  US$43,960,851   US$49,362,580 
Other operating income   1,532,006    1,471,014 
Selling and distribution expenses   15,250,216    18,050,068 
General and administrative expenses   15,784,330    12,786,335 
Research and development expenses   5,831,756    5,934,377 
Income from operations   8,626,555    14,062,814 
Interest income   683,561    86,839 
Other income   2,616,586    352,130 
Interest expense   (804,321)   (1,126,212)
Other expenses   (807,407)   (1,011,795)
Income before income tax expense  US$10,314,974   US$12,363,776 
CAPITAL EXPENDITURE          
Commercial Vehicle Brake Systems  US$1,973,423   US$2,437,413 
Passenger Vehicle Brake Systems   467,088    557,158 
Total  US$2,440,511   US$2,994,571 
DEPRECIATION AND AMORTIZATION          
Commercial Vehicle Brake Systems  US$4,650,260   US$4,556,349 
Passenger Vehicle Brake Systems   1,114,878    1,041,518 
Total  US$5,765,138   US$5,597,867 

 

   September 30,
2015
   December 31,
2014
 
     
TOTAL ASSETS          
Commercial Vehicle Brake Systems  US$243,240,166   US$234,186,022 
Passenger Vehicle Brake Systems   59,787,324    52,720,240 
           
Total  US$303,027,490   US$286,906,262 

 

   September 30,
2015
   December 31,
2014
 
     
LONG-LIVED ASSETS          
Commercial Vehicle Brake Systems  US$43,876,817   US$48,956,149 
Passenger Vehicle Brake Systems   10,784,721    11,021,067 
           
Total  US$54,661,538   US$59,977,216 

 

 17 

 

 

NOTE P – CONTINGENCIES

 

(1) According to the laws of China, the Chinese 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 all buildings on the land from Ruili Group for approximately US$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 negotiation 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. The Company reserved the relevant tax amount of RMB 4,560,000 (approximately US$745,220). 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. 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 provided the guarantee for the credit line granted to Ruili Group by the Bank of Ningbo in the amount of RMB 108,000,000 (approximately US$17,182,404) for the period from August 22, 2014 to August 21, 2015. The Company also provides the guarantee for Ruili Group related to the credit line granted by China Zheshang Bank in the amount of RMB 146,960,000 (approximately US$24,016,996) from December 9, 2014 to December 9, 2015.

 

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, 2014, 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, 2014.

 

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

 

Sales

 

The following tables present certain financial information about our segments’ sales for the periods presented:

 

   Three Months Ended   Three Months Ended 
   September 30, 2015   September 30, 2014 
   (U.S. dollars in
millions except
percentages)
 
Commercial Vehicle Brake Systems  US$40.4    80.3%  US$48.1    81.9%
Passenger Vehicle Brake Systems  US$9.9    19.7%  US$10.6    18.1%
                     
Total  US$50.3    100.0%  US$58.7    100.0%

 

   Nine Months Ended   Nine Months Ended 
   September 30, 2015   September 30, 2014 
   (U.S.  dollars in
millions except
percentages)
 
Commercial Vehicle Brake Systems  US$130.4    80.6%  US$142.0    81.4%
Passenger Vehicle Brake Systems  US$31.4    19.4%  US$32.4    18.6%
                     
Total  US$161.8    100.0%  US$174.4    100.0%

 

 19 

 

 

Net sales were US$50,323,832 and US$58,702,505 for the three months ended September 30, 2015 and 2014, respectively, a decrease of US$8.4 million, or 14.3%. Net sales were US$161,796,676 and US$174,419,540 for the nine months ended September 30, 2015 and 2014, respectively, a decrease of US$12.6 million, or 7.2%. The decrease was mainly due to the decline of the production and sales of the commercial vehicles in the automobile industry.

 

The sales from Commercial Vehicle Brake Systems decreased by US$7.7 million, or 16.0%, to US$40.4 million for the third fiscal quarter of 2015, compared to US$48.1 million for the same period of 2014. The sales from Commercial Vehicle Brake Systems decreased by US$11.6 million, or 8.1%, to US$130.4 million for the nine months ended September 30, 2015, compared to US$142.0 million for the same period of 2014. The decline of the production and sales of commercial vehicles in 2015 in the automobile industry impacted the sales of the Commercial Vehicle Brake Systems.

 

The sales from Passenger Vehicle Brake Systems decreased by US$0.7 million, or 6.6%, to US$9.9 million for the third fiscal quarter of 2015, compared to US$10.6 million for the same period of 2014. The sales from Passenger Vehicle Brake Systems decreased by US$1.0 million, or 3.2%, to US$31.4 million for the nine months ended September 30, 2015, compared to US$32.4 million for the same period of 2014. The decrease was mainly due to the adjustment of our customer structure in the third fiscal quarter of 2015, namely reducing or suspending sales to customers who have long-term overdue payment or who place relatively small orders.

 

A breakdown of net sales revenue for China OEM market, China aftermarket and international market for the third fiscal quarter of the 2015 and 2014, respectively, is set forth below:

 

  

Three Months

Ended

September 30,

2015

  

Percent

of

Total

Sales

  

Three

Months

Ended

September

30, 2014

  

Percent

of

Total

Sales

  

Percentage

Change

 
   (U.S. dollars in million, except percentages)     
China OEM market  US$20.1    40.0%  US$24.0    40.9%   -16.1%
China Aftermarket  US$15.3    30.4%  US$17.2    29.3%   -11.2%
International market  US$14.9    29.6%  US$17.5    29.8%   -14.8%
Total  US$50.3    100.0%  US$58.7    100.0%   -14.3%

 

 20 

 

 

A breakdown of net sales revenues for China OEM markets, China aftermarket and international market for the nine months ended September 30, 2015 and 2014, respectively, is set forth below:

 

              Nine              
    Nine Months     Percent     Months     Percent        
    Ended     of     Ended     of        
    September 30,     Total     September     Total     Percentage  
    2015     Sales     30, 2014     Sales     Change  
    (U.S. dollars in million, except percentages)  
China OEM market   US$ 74.4       46.0 %   US$ 84.5       48.5 %     -11.9 %
China Aftermarket   US$ 41.7       25.8 %   US$ 43.1       24.7 %     -3.3 %
International market   US$ 45.7       28.2 %   US$ 46.8       26.8 %     -2.3 %
Total   US$ 161.8       100.0 %   US$ 174.4       100.0 %     -7.2 %

 

Our sales to the Chinese OEM market decreased by 16.1% from the third quarter of 2014 to US$20.1 million and decreased by 11.9% from the nine months ended September 30, 2015 to 74.4 million due to the decline of the production and sales of the commercial vehicles in the automobile industry in 2015.

 

Our sales to the China aftermarket decreased by US$1.9 million, or 11.2%, to US$15.3 million for the third quarter of 2015, compared to US$17.2 million for the same period of 2014. Our sales to the China aftermarket decreased by US$1.4 million, or 3.3%, to US$41.7 million for the nine months ended September 30, 2015, compared to US$43.1 million for the same period of 2014. The usage of heavy-duty trucks in the construction of real estate development projects and infrastructure projects was reduced in China in the third quarter of 2015, which resulted in the reduced replacement of auto parts. We will continue with our strategies to further optimize our sales network and to help further penetrate new markets. Accelerated urbanization and the Chinese government’s increased support for public transportation favor our expansion in the bus aftermarket.

 

Our export sales decreased by US$2.6 million, or 14.8%, to US$14.9 million for the third fiscal quarter of 2015, as compared to US$17.5 million for the same period of 2014. Our export sales decreased by US$1.1 million, or 2.3%, to US$45.7 million for the nine months ended September 30, 2015, as compared to US$46.8 million for the same period of 2014. The decrease in export sales was mainly due to the truck production decline and currency depreciation in some countries.

 

Cost of Sales and Gross Profit

 

Cost of sales for the three months ended September 30, 2015 was US$36,622,501, a decrease of US$6.6 million, or 15.3%, from US$43,240,746 for the three months ended September 30, 2014. Cost of sales for the nine months ended September 30, 2015 was US$117,835,825, a decrease of US$7.2 million, or 5.8%, from US$125,056,960 for the same period last year. Our gross profit decreased by 11.4% from US$15,461,759 for the period of 2014 to US$13,701,331 for the three months ended September 30, 2015. Our gross profit decreased by 10.9% from US$49,362,580 for the nine months ended September 30, 2014 to US$43,960,851 for the same period of 2015.

 

Gross margin increased to 27.2% from 26.3% for the three months ended September 30, 2015 compared with the same period of 2014. The increase was mainly due to increased sales of higher margin products in the third fiscal quarter of 2015. We intend to focus in 2015 on increasing production efficiency, improving the technologies of products and improving our product portfolio, which we believe will help us to maintain or increase our gross profit margins. Gross margin decreased to 27.2% from 28.3% for the nine months ended September 30, 2015 as compared with the same period of 2014 due to our commencement of price promotion in the aftermarket and international market in 2015, which we intended to strengthen our competitiveness and increase our market share. Increased labor costs also contributed to the decrease in our gross margin.

 

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Cost of sales from Commercial Vehicle Brake Systems for the three months ended September 30, 2015 were US$29.2 million, a decrease of US$6.0 million, or 17.0%, from US$35.2 million for the same period last year. Cost of sales from Commercial Vehicle Brake Systems for the nine months ended September 30, 2015 were US$95.3 million, a decrease of US$7.6 million, or 7.4%, from US$102.9 million for the same period of 2014. The gross profit from Commercial Vehicle Brake Systems decreased by 13.4% from US$12.9 million for three months ended September 30, 2014 to US$11.2 million for the three months ended September 30, 2015. The gross profit from Commercial Vehicle Brake Systems decreased by 10.1% from US$39.1 million for the nine months ended September 30, 2014 to US$35.1 for the same period of 2015. Gross margin from Commercial Vehicle Brake Systems increased to 27.7% from 26.9% for the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The increase was mainly due to increased sales of higher margin products in the third fiscal quarter of 2015. Gross margin from Commercial Vehicle Brake Systems decreased to 26.9% from 27.5% for the nine months ended September 30, 2015 compared with the same period of 2014. The decrease was mainly due to our commencement of price promotion in the aftermarket and international market in 2015, which we intended to strengthen our competitiveness and increase our market share. Increased labor costs also contributed to the decrease in our gross margin.

 

Cost of sales from Passenger Vehicle Brake Systems for the three months ended September 30, 2015 was US$7.4 million, a decrease of US$0.6 million, or 8.0%, from US$8.1 million for the three-month period ended September 30, 2014. Cost of sales from Passenger Vehicle Brake Systems for the nine months ended September 30, 2015 was US$22.6 million, an increase of US$0.4 million or 1.8% from US$22.2 million for the same period of 2014. The gross profit from Passenger Vehicle Brake Systems decreased by 1.3% from US$2.54 million for the three-month period ended September 30, 2014 to US$2.51 million for the three-month period ended September 30, 2015. The gross profit from Passenger Vehicle Brake Systems decreased by 14.0% from US$10.3 million for the nine months ended September 30, 2014 to US$8.8 million for the same period of 2015. Gross margin from Passenger Vehicle Brake Systems increased to 25.3% from 24.0% for the three months ended September 30, 2015, as compared with the same period in 2014. The increase was mainly due to the adjustment of our customer structure and products portfolio in the third fiscal quarter of 2015. Gross margin from Passenger Vehicle Brake Systems decreased to 28.1% from 31.6% for the nine months ended September 30, 2015, as compared with the same period in 2014.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were US$4,813,129 for the three months ended September 30, 2015, as compared to US$5,871,463 for the same period of 2014, a decrease of US$1,058,334, or 18.0%. Selling and distribution expenses were US$15,250,216 for the nine months ended September 30, 2015, as compared to US$18,050,068 for the same period of 2014, a decrease of US$2,799,852, or 15.5%. The decrease was mainly due to decreased freight expense and packaging expenses. 

 

As a percentage of sales revenue, selling expenses decreased to 9.6% for the three months ended September 30, 2015, as compared to 10.0% for the same period in 2014. As a percentage of sales revenue, selling expenses decreased to 9.4% for the nine months ended September 30, 2015, as compared to 10.3% for the same period in 2014.

 

General and Administrative Expenses

 

General and administrative expenses were US$5,634,735 for the three months ended September 30, 2015, as compared to US$3,759,307 for the same period of 2014, an increase of US$1,875,428, or 49.9%. General and administrative expenses were US$15,784,330 for the nine months ended September 30, 2015, as compared to US$12,786,335 for the same period of 2014, an increase of US$2,997,995, or 23.4%. The increase was mainly due to the increase in allowance for doubtful accounts during this quarter. As a percentage of sales revenue, general and administrative expenses increased to 11.2% for the three months ended September 30, 2015, as compared to 6.4% for the same period in 2014. As a percentage of sales revenue, general and administrative expenses increased to 9.8% for the nine months ended September 30, 2015, as compared to 7.3% for the same period in 2014. 

 

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, 2015, research and development expenses were US$2,261,665, as compared to US$2,242,620 for the same period of 2014, an increase of US$19,045. For the nine months ended September 30, 2015, research and development expenses were US$5,831,756, as compared to US$5,934,377 for the same period of 2014, a decrease of US$102,621.

 

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Other Operating Income

 

Other operating income was US$463,198 for the three months ended September 30, 2015, as compared to US$545,752 for the three months ended September 30, 2014, a decrease of US$82,554. The decrease was mainly due to the decrease in sales of raw material scraps for the three months ended September 30, 2015. Other operating income was US$1,532,006 for the nine months ended September 30, 2015, as compared to US$1,471,014 for the nine months ended September 30, 2014, an increase of US$60,992. The increase was mainly due to an increase in sales of raw material scrap for the nine months ended September 30, 2015.

 

Depreciation and Amortization

 

Depreciation and amortization expense decreased to US$1,853,866 for the three months ended September 30, 2015, compared with that of US$1,865,486 for the same period of 2014, a decrease of US$11,620. 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, 2015. Depreciation and amortization expenses increased to US$5,765,138 for the nine months ended September 30, 2015, as compared to US$5,597,867 for the same period of 2014, an increase of US$167,271. The increase in depreciation and amortization expense was primarily due to the addition of purchased production equipment.

 

Interest Income

 

Interest income for the three months ended September 30, 2015, increased by US$136,566 to US$162,770 from US$26,204 for the same period of 2014. Interest income for the nine months ended September 30, 2015, increased by US$596,722 to US$683,561 from US$86,839 for the same period of 2014, mainly due to increased short term investments during the periods.

 

Interest Expenses

 

Interest expenses for the three months ended September 30, 2015 decreased by US$8,361 to US$395,121 from US$403,482 for the same period of 2014. Interest expenses for the three months ended September 30, 2015 decreased by US$321,891 to US$804,321 from US$1,126,212 for the same period of 2014 mainly due to decreased interest rate. In addition, interest expenses related to the discount of bank acceptance notes received from customers also decreased.

 

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 was valid for three years and provided 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 according to the relevant PRC income tax laws. Accordingly, it was taxed at a 15% rate in 2012 through 2014. Upon the expiration of the “High-Tech Enterprise” certificate in 2015, the Company is undergoing the re-assessment of the certificate by the government and is currently subject to a tax rate of 25%.

 

 23 

 

 

Income tax expense was US$427,905 for the three months ended September 30, 2015, as compared to US$391,988 for the three months ended September 30, 2014. Income tax expense was US$2,220,327 for the nine months ended September 30, 2015, as compared to US$1,556,433 for the nine months ended September 30, 2014, mainly due to higher tax rate.

 

Net Income Attributable to Non-Controlling Interest in Subsidiaries

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH, in each case held by our Joint Venture partners. Net income attributable to non-controlling interest in subsidiaries amounted to US$373,067 and US$262,813 for the third fiscal quarter ended September 30, 2015 and 2014, respectively. Net income attributable to non-controlling interest in subsidiaries amounted to US$734,265 and US$1,003,631 for the nine months ended September 30, 2015 and 2014, respectively.

 

Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the fiscal quarter ended September 30, 2015 decreased by US$852,909 to US$2,048,026 from US$2,900,935 for the fiscal quarter ended September 30, 2014. The net income attributable to stockholders for the nine months ended September 30, 2015 decreased by US$2,443,330 to US$7,360,382 from US$9,803,712 for the nine months ended September 30, 2014 due to the decrease in our sales and gross profit. Earnings per share (“EPS”), both basic and diluted, for the fiscal quarter ended September 30, 2015 and 2014, were US$0.11 and US$0.15. EPS, both basic and diluted, for the nine months ended September 30, 2015 and 2014, were US$0.38 and US$0.51, respectively.

 

FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

As of September 30, 2015, the Company had cash and cash equivalents of US$5,742,833 compared to US$14,009,597 as of December 31, 2014. The Company had working capital of US$165,730,580 at September 30, 2015 compared to US$163,947,851 at December 31, 2014, reflecting current ratios of 3.01:1 and 3.60:1, respectively.

 

OPERATING. Net cash provided by operating activities was US$38,985,287 for nine months ended September 30, 2015, an increase of US$27.6 million, as compared with US$11,407,243 in the same period in 2014. Such increase was primarily due to the increased cash inflow resulting from changes in inventories.

 

INVESTING. During the nine months ended September 30, 2015, the Company expended net cash of US$57,376,908 in investing activities mainly for short term investments. For the nine months ended September 30, 2014, the Company expended net cash of US$2,937,232 in investing activities.

 

FINANCING. During the nine month period ended September 30, 2015, the cash provided by financing activities was US$10,479,679. Cash provided by financing activities was US$682,594 for the nine months ended September 30, 2014.

 

The Company has taken a number of steps to improve the management of our cash flow. We place more emphasis on collection of accounts receivable from our customers, and 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, 2015, 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.

 

 24 

 

 

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 all buildings on the land in the same transaction. The purchase price of land use right and building amounted to approximately US$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 will continue negotiations in furtherance of our effort and to obtain the land use rights certificate as soon as practicable.

 

Even if the Company is unable to timely resolve obtain the land use right certificate for the land and related building, the Company believes that 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 the Ruili Group, a related party. The 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.        We do not believe that a third party would have a reasonable basis for opposing the Company’s use of the land, because we believe no third party has any interest in the land use right or property ownership right, other than the Ruili Group and the government.

 

3.        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.

 

4.        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 was 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.

 

5.        The Company has reserved tax payables in the amount of RMB 4,560,000 (approximately US$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 considers 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.

 

CONTRACTUAL OBLIGATIONS

 

As of September 30, 2015, we had no material changes outside the ordinary course of business in our contractual obligations

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable.

 

 25 

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures:

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs. As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of September 30, 2015 was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(b) and 15d-15(b) of the Exchange Act). Based on this evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures, as of September 30, 2015, were effective, in all material respects, for the purpose stated above.

 

Changes in Internal Control over Financial Reporting:

 

There were no changes in the Company’s internal control over financial reporting during the three months ended September 30, 2015 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

 

We are involved in litigation matters and are subject to claims arising in the ordinary course of business that we do not believe will have a material adverse effect upon our business, financial condition or results of operations, although we can offer no assurance as to the ultimate outcome of any such matters.

 

ITEM 1A. RISK FACTORS

 

Part I, Item 1A. “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2014 includes a detailed discussion of risk factors that could materially affect our business, financial condition or results of operations. There have been no material changes from the risk factors disclosed in that report.

 

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

 

 The board of directors (the "Board") of SORL has received a preliminary non-binding proposal letter, dated October 30, 2015, from Mr. Xiaoping Zhang, Chairman and Chief Executive Officer of the Company, Ms. Shuping Chi and Mr. Xiaofeng Zhang, directors of the Company (collectively, the "Consortium Members"), to acquire all of the outstanding shares of the Company not owned by them or their affiliates for US2.84 in cash per share.  The Consortium Members currently own in the aggregate approximately 58.8 percent of the total outstanding common shares of SORL. The Board intends formed a special committee consisting of independent directors to consider the proposal. The Board expects that the special committee will retain independent advisors, including independent financial and legal advisors, to assist it in this process.

 

 26 

 

 

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)
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema Document
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document

 

(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.

 

 27 

 

 

 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 16, 2015 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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