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EX-31.1 - EXHIBIT 31.1 - SORL Auto Parts Incv438718_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - SORL Auto Parts Incv438718_ex31-2.htm
EX-32 - EXHIBIT 32 - SORL Auto Parts Incv438718_ex32.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

xQUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended March 31, 2016

 

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

For the transition period from _________ to _________

 

Commission file number 000-11991

 

SORL AUTO PARTS, INC.

(Exact name of registrant as specified in its charter)

 

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

 

No. 1169 Yumeng Road

Ruian Economic Development District

Ruian City, Zhejiang Province

People’s Republic Of China

(Address of principal executive offices)

 

 

 

86-577-6581-7720

(Registrant’s telephone number)

 

 

 

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

Yes x  No ¨

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

Yes  x   No ¨

 

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

Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer ¨ Smaller Reporting Company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

Yes ¨ No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

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

As of May 16, 2016 there were 19,304,921 shares of common stock outstanding

 

 

 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Three Months Ended March 31, 2016

 

INDEX

 

    Page
     
PART I. FINANCIAL INFORMATION (Unaudited)  
     
Item 1. Financial Statements:  
     
  Consolidated Balance Sheets as of March 31, 2016 (Unaudited) and December 31, 2015 3
     
  Consolidated Statements of Income and Comprehensive Income for the Three Months Ended March 31, 2016 and 2015 (Unaudited) 4
     
  Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015 (Unaudited) 5
     
  Consolidated Statements of Changes in Equity for the Three Months Ended March 31, 2016 (Unaudited) 6
     
  Notes to Consolidated Financial Statements (Unaudited) 7
     
Item 2. Management’s Discussion and Analysis or Financial Condition and Results of Operations 20
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
     
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 27

 

 2 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Balance Sheets

March 31, 2016 and December 31, 2015

 

   March 31, 2016   December 31, 2015 
   (Unaudited)     
Assets          
Current Assets          
Cash and cash equivalents  US$6,103,766   US$30,230,828 
Accounts receivable, net   71,711,260    71,823,328 
Bank acceptance notes from customers   28,096,561    22,870,791 
Short term investments   58,527,775    61,007,709 
Inventories   68,154,818    73,661,860 
Prepayments, including $1,754,420 and $0 prepayments to related parties at March 31, 2016 and December 31, 2015, respectively   8,233,271    3,350,607 
Due from related party   18,247,384    - 
Prepaid capital lease interest   54,189    93,458 
Restricted cash   1,067,461    785,999 
Other current assets, net   1,463,295    1,241,864 
Deferred tax assets   3,506,814    2,909,729 
Total Current Assets   265,166,594    267,976,173 
           
Property, plant and equipment, net   37,053,716    37,561,905 
Land use rights, net   13,208,647    13,232,149 
Intangible assets, net   21,050    23,854 
Security deposits on lease agreement   1,768,800    1,759,975 
Total Non-Current Assets   52,052,213    52,577,883 
Total Assets  US$317,218,807   US$320,554,056 
           
Liabilities and Equity          
Current Liabilities          
Accounts payable and bank acceptance notes to vendors, including $496,146 and $1,133,537 due to related parties at March 31, 2016 and December 31, 2015, respectively  US$37,640,498   US$35,292,277 
Deposit received from customers   21,304,652    20,012,087 
Short term bank loans   17,447,655    23,367,207 
Accrued expenses   11,964,864    13,870,587 
Capital lease obligations   2,653,200    3,519,949 
Other current liabilities, including $97,404 and $0 due to related parties at March 31, 2016 and December 31, 2015, respectively   2,198,308    2,067,449 
Total Current Liabilities   93,209,177    98,129,556 
Total Liabilities   93,209,177    98,129,556 
           
Equity          
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of March 31, 2016 and December 31, 2015   -    - 
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of March 31, 2016 and December 31, 2015   38,609    38,609 
Additional paid-in capital   42,199,014    42,199,014 
Reserves   13,260,606    13,207,972 
Accumulated other comprehensive income   16,658,615    15,662,639 
Retained earnings   129,433,106    129,055,099 
Total SORL Auto Parts, Inc. Stockholders' Equity   201,589,950    200,163,333 
Noncontrolling Interest In Subsidiaries   22,419,680    22,261,167 
Total Equity   224,009,630    222,424,500 
Total Liabilities and Equity  US$317,218,807   US$320,554,056 

 

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 Ended March 31, 2016 and 2015 (Unaudited)

 

   Three Months Ended March 31, 
   2016   2015 
         
Net Sales  US$53,836,728   US$52,197,966 
Include: sales to related parties   2,580,846    1,011,924 
Cost of sales   39,397,649    38,466,892 
Gross profit   14,439,079    13,731,074 
           
Expenses:          
Selling and distribution expenses   5,562,432    5,350,998 
General and administrative expenses   6,929,858    2,719,372 
Research and development expenses   1,743,687    1,712,621 
Total operating expenses   14,235,977    9,782,991 
           
Other operating income   914,205    585,717 
           
Income from operations   1,117,307    4,533,800 
           
Interest income   88,102    110,955 
Government grants   4,757    25,980 
Other income   45,589    67,411 
Interest expenses   (174,460)   (166,656)
Other expenses   (637,629)   (370,688)
           
Income before income taxes provision / benefit   443,666    4,200,802 
           
Income taxes provision (benefit)   (34,824)   998,278 
           
Net income  US$478,490   US$3,202,524 
           
Net income attributable to noncontrolling interest In subsidiaries   47,849    152,243 
           
Net income attributable to common stockholders  US$430,641   US$3,050,281 
           
Comprehensive income:          
           
Net income  US$478,490   US$3,202,524 
Foreign currency translation adjustments   1,106,640    (813,243)
Comprehensive income   1,585,130    2,389,281 
Comprehensive income attributable to noncontrolling interest in subsidiaries   158,513    88,568 
Comprehensive income attributable to common shareholders  US$1,426,617   US$2,300,713 
           
Weighted average common share - basic   19,304,921    19,304,921 
           
Weighted average common share - diluted   19,304,921    19,304,921 
           
EPS - basic  US$0.02   US$0.16 
           
EPS - diluted  US$0.02   US$0.16 

 

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 Three Months Ended March 31, 2016 and 2015 (Unaudited)

 

   Three Months Ended March 31, 
   2016   2015 
         
Cash Flows From Operating Activities          
Net Income  US$478,490   US$3,202,524 
Adjustments to reconcile net income to net cash used in operating activities:          
           
Allowance for doubtful accounts   3,676,683    (338,319)
Depreciation and amortization   1,733,874    1,937,064 
Deferred income tax   (596,802)   (162,875)
Changes in assets and liabilities:          
Accounts receivable   (3,192,855)   (4,556,747)
Bank acceptance notes from customers   (5,236,626)   720,695 
Other currents assets   (216,932)   (557,779)
Inventories   6,020,763    3,937,590 
Prepayments   (4,828,231)   (492,545)
Prepaid capital lease interest   40,714    87,570 
Accounts payable and bank acceptance notes to vendors   2,389,292    (4,765,769)
Income tax payable   -    394,992 
Deposits received from customers   1,221,498    1,716,287 
Other current liabilities and accrued expenses   (1,900,667)   (1,608,205)
Net Cash Flows Used In Operating Activities   (410,799)   (485,517)
           
Cash Flows From Investing Activities          
Change in short term investments   2,854,289    (10,157,715)
Acquisition of property and equipment   (1,247,024)   (859,313)
Change in restricted cash   (284,338)   - 
Advance to related party   (18,695,590)   - 
Net Cash Flows Used In Investing Activities   (17,372,663)   (11,017,028)
           
Cash Flows From Financing Activities          
Proceeds from bank loans   13,795,728    8,643,266 
Repayment of bank loans   (20,050,944)   (5,470,663)
Repayment of capital lease   (906,123)   (932,092)
Net Cash Flows Provided By (Used In) Financing Activities   (7,161,339)   2,240,511 
           
Effects on changes in foreign exchange rate   817,739    (20,110)
           
Net change in cash and cash equivalents   (24,127,062)   (9,282,144)
           
Cash and cash equivalents- beginning of the period   30,230,828    14,009,597 
           
Cash and cash equivalents - end of the period  US$6,103,766    US$4,727,453  
           
Supplemental Cash Flow Disclosures:          
Interest paid  US$275,913    US$191,154  
Income taxes paid  US$677,301    US$766,161  

 

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 Equity

For The Three Months Ended March 31, 2016 (Unaudited)

 

                      Accumulated
   Total SORL Auto
         
   Number      Additional          Other   Parts, Inc.       
   of   Common   Paid-in       Retained   Comprehensive   Stockholders'   Noncontrolling   Total 
   Shares   Stock   Capital   Reserves   Earnings   Income   Equity   Interest   Equity 
Beginning Balance – December 31, 2015   19,304,921   $38,609   $42,199,014   $13,207,972   $129,055,099   $15,662,639   $200,163,333   $22,261,167   $222,424,500 
                                              
Net income   -    -    -    -    430,641    -    430,641    47,849    478,490 
                                              
Foreign currency translation adjustment   -    -    -    -    -    995,976    995,976    110,664    1,106,640 
                                              
Transfer to reserve   -    -    -    52,634    (52,634)   -    -    -    - 
                                              
Ending Balance - March 31, 2016   19,304,921   $38,609   $42,199,014   $13,260,606   $129,433,106   $16,658,615   $201,589,950   $22,419,680   $224,009,630 

 

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

March 31, 2016

(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”). 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”), a related party under common control, 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, through its wholly owned subsidiary, Fairford, entered into a joint venture agreement with MGR Hong Kong Limited (“MGR”), a Hong Kong-based global auto parts distribution specialist firm and an unaffiliated Taiwanese investor. The joint venture was named SORL International Holding, Ltd. (“SIH”) based in Hong Kong. SORL held a 60% interest in the joint venture, MGR held a 30% interest, and the Taiwanese investor held a 10% interest. SIH was 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. In December 2015, due to poor financial performance of SIH, Fairfold sold all of its interest in SIH to the Taiwanese investor for US$77 (HK$600). The loss on disposal of SIH was $3,170,821.

 

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, 2015 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, 2015. 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, 2015, 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.

 

 7 

 

 

(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.

 

Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, freemarket dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated. It is not, however, practical to determine the fair value of amounts due from/to related parties due to their related party nature.

 

d.SHORT TERM INVESTMENTS

 

The Company’s short term investments include term deposits with an original maturity from three months to one year with financial institutions. Term deposits in the amount of $21,667,802 (RMB 140,000,000) were pledged for the credit line granted to Ruili Group, a related party, by Bank of Ningbo for the period from March 24, 2015 to March 24, 2016. The pledge term ends two years after the main borrowing contract expires. Term deposit in the amount of $6,190,800 (RMB 40,000,000) was pledged as security interest for the bank acceptance notes payable issued to Hangzhou Xiangwei Wuzi Co., Ltd, a related party controlled by the relative of Ms. Shu Ping Chi, by Zhejiang Chouzhou Commercial Bank for the period from December 17, 2015 to June 17, 2016.

 

e.RESTRICTED CASH

 

Restricted cash mainly represents bank deposits used to pledge the bank acceptance notes. The Company entered into credit agreements with commercial banks in China (“endorsing banks”) which agree to provide credit within stipulated limits. Within the stipulated credit limits, the Company can issue bank acceptance notes to its suppliers as payments for the purchases. In order to issue bank acceptance notes, the Company is generally required to make initial deposits or pledge note receivables to the endorsing banks in amounts of certain percentage of the face amount of the bank acceptance notes to be issued by the Company. The cash in such accounts is restricted for use over the terms of the bank acceptance notes, which are normally three to six months.

 

f.RELATED PARTY TRANSACTIONS

 

A related party is generally defined as (i) any person that holds 10% or more of the Company’s securities and their immediate families, (ii) the Company’s management, (iii) someone that directly or indirectly controls, is controlled by or is under common control with the Company, or (iv) anyone who can significantly influence the financial and operating decisions of the Company. A transaction is considered to be a related party transaction when there is a transfer of resources or obligations between related parties. The Company conducts business with its related parties in the ordinary course of business.

 

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g.NOTES RECEIVABLE

 

Notes receivable generally due within six months are issued by some customers to pay certain outstanding receivable balances to the Company with specific payment terms and definitive due dates. Notes receivable do not bear interest. As of March 31, 2016 and December 31, 2015, notes receivables in the amount of $21,487,155 and $13,647,583, respectively, were pledged to endorsing banks to issue bank acceptance notes. The banks charge discount fees if the Company chooses to discount the notes receivables for cash before the maturity of the notes and such discount fees are included in interest expenses.

 

h.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.

 

i.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.

 

j.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 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.

 

k.RECLASSIFICATIONS

 

Certain prior period 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 March 2016, the FASB issued ASU 2016-08, “ Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)”. 'The amendments in this ASU are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations by amending certain existing illustrative examples and adding additional illustrative examples to assist in the application of the guidance. The effective date and transition of these amendments is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. Public entities should apply the amendments in ASU 2014-09 for annual reporting periods beginning after December 15, 2017, including interim reporting periods therein. The Company is currently in the process of evaluating the impact of the adoption on its consolidated financial statements.

 

 9 

 

 

In April 2016, the FASB issued ASU 2016- 10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing”. The amendments add further guidance on identifying performance obligations and also to improve the operability and understandability of the licensing implementation guidance. The amendments do not change the core principle of the guidance in Topic 606. Public entities should apply the amendments for annual reporting periods beginning after December 15, 2017, including interim reporting periods therein. Early application for public entities 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.

 

NOTE D - RELATED PARTY TRANSACTIONS

 

The Company continues to purchase primarily 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 automotive components from three other related parties, Guangzhou Kormee Automotive Electronic Control Co., Ltd. (“Guangzhou Kormee”), Ruian Kormee Vehicle Brake Co., Ltd. (“Ruian Kormee”) and Shanghai Dachao Electric Technology Co., Ltd. (“Shanghai Dachao”). Guangzhou Kormee is controlled by the Ruili Group and Ruian Kormee is the wholly-owned subsidiary of Guangzhou Kormee. Ruili Group owns 49% equity interest in Shanghai Dachao. The Company sells certain automotive products to the Ruili Group. The Company also sells scrap materials and parts to Guangzhou Kormee and Ruian Kormee. In addition, during the three months ended March 31, 2016, the Company advanced $18,247,384 to Ruili Group for working capital purpose. The Company collects dormitory utility fees from employees and pays to Ruili Group periodically which is recorded as other payables. As of March 31, 2016, the payable balance was $97,404.

 

The following related party transactions occurred for the three months ended March 31, 2016 and 2015:

 

   Three Months Ended March 31, 
   2016   2015 
PURCHASES FROM:          
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.  $392,924   $286,415 
Ruian Kormee Vehicle Brake Co., Ltd.   130,513    74,603 
Ruili Group Co., Ltd.   865,798    810,864 
Shanghai Dachao Electric Technology Co., Ltd.   33,744    - 
Total Purchases  $1,422,979   $1,171,882 
           
SALES TO:          
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.  $617,846   $94,896 
Ruian Kormee Vehicle Brake Co., Ltd.   573    17,315 
Ruili Group Co., Ltd.   2,580,846    1,011,924 
Total Sales  $3,199,265   $1,124,135 

 

 10 

 

 

During the three months ended March 31, 2016 and 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.

 

   March 31,   December 31, 
   2016   2015 
PREPAYMENTS TO RELATED PARTIES          
Ruili Group Co., Ltd.  $1,451,651   $ 
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.   302,769     
Total  $1,754,420   $ 
           
DUE FROM RELATED PARTIES        
Ruili Group Co., Ltd.  $18,247,384   $ 
Total  $18,247,384   $ 
           
ACCOUNTS PAYABLE TO RELATED PARTIES          
Ruian Kormee Vehicle Brake Co., Ltd.  $488,735   $340,175 
Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.       75,968 
Ruili Group Co., Ltd.       697,643 
Shanghai Dachao Electric Technology Co., Ltd.   7,411    19,751 
Total  $496,146   $1,133,537 
           
OTHER PAYABLES TO RELATED PARTIES        
Ruili Group Co., Ltd.  $97,404   $ 
Total  $97,404   $ 

 

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

 

 11 

 

 

In addition, the Company provided a guarantee for credit line granted to Ruili Group by Bank of Ningbo in a maximum amount of RMB 168,000,000 (approximately $25,871,627) for the period from March 24, 2015 to March 24, 2016. The pledge term ends two years after the main borrowing contract expires. As of March 31, 2016, the term deposits were still under pledge. As of March 31, 2016, the Company pledged a 6-month fixed term deposit of RMB 54,000,000 (approximately $8,315,880) with a maturity date of May 19, 2016, and a 6-month fixed term deposit of RMB 86,000,000 (approximately $13,243,809) with a maturity date of May 18, 2016. The balance of these fixed term deposits was included in short term investments.

 

The Company provided a guarantee for the credit line granted to Ruili Group by China Everbright Bank in the amount of RMB 60,000,000 (approximately $9,239,867) for a period from February 26, 2015 until two years after the due date of each loan withdrawn by Ruili Group under the credit line.

 

The Company provided a guarantee for the credit line granted to Ruili Group by China Guangfa Bank in the amount of RMB 54,000,000 (approximately $8,315,880) for a period from September 22, 2015 until two years after the due date of each loan withdrawn by Ruili Group under the credit line.

 

The Company provided a guarantee for the credit line granted to Ruili Group by the China Merchants Bank in the amount of RMB 50,000,000 (approximately $7,699,889) for a period from July 29, 2015 until two years after the due date of each loan withdrawn by Ruili Group under the credit line.

 

The Company pledged its term deposit of RMB 40,000,000 (approximately $6,159,911) for the bank acceptance notes issued to Hangzhou Xiangwei Wuzi Co., Ltd, a related party controlled by the relative of Ms. Shu Ping Chi, by Zhejiang Chouzhou Commercial Bank for the period from December 17, 2015 to June 17, 2016.

 

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 $17,182,404) for the period from August 22, 2014 to August 21, 2015. The pledge term ends two years after the main borrowing contract expires.

 

NOTE E - ACCOUNTS RECEIVABLE

 

Accounts receivable, net consisted of the following:

 

   March 31,   December 31, 
   2016   2015 
Accounts receivable  $87,435,754   $83,898,730 
Less: allowance for doubtful accounts   (15,724,494)   (12,075,402)
Accounts receivable, net  $71,711,260   $71,823,328 

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the quarters ended March 31, 2016 and 2015. The changes in the allowance for doubtful accounts at March 31, 2016 and December 31, 2015 are summarized as follows:

 

   March 31,   December 31, 
   2016   2015 
Beginning balance  $12,075,402   $6,475,587 
Add: Increase to allowance   3,649,092    5,599,815 
Less: Accounts written off        
Ending balance  $15,724,494   $12,075,402 

 

 12 

 

 

NOTE F - INVENTORIES

 

At March 31, 2016 and December 31, 2015, inventories consisted of the following:

 

   March 31,   December 31, 
   2016   2015 
Raw Materials  $9,075,542   $13,038,945 
Work in process   26,068,514    28,786,709 
Finished Goods   33,010,762    31,836,206 
Less: Write-down of inventories        
Total Inventory  $68,154,818   $73,661,860 

 

NOTE G - PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment consisted of the following at March 31, 2016 and December 31, 2015:

 

   March 31,   December 31, 
   2016   2015 
Machinery  $53,262,624   $50,680,639 
Molds   1,350,468    1,343,730 
Office equipment   2,099,591    2,077,411 
Vehicles   2,089,777    1,983,028 
Buildings   7,795,815    7,756,917 
Machinery held under capital lease   27,624,655    29,012,601 
Leasehold improvements   492,335    489,878 
Sub-Total   94,715,265    93,344,204 
           
Less: Accumulated depreciation   (57,661,549)   (55,782,299)
           
Property, plant and equipment, net  $37,053,716   $37,561,905 

 

Depreciation expense charged to operations was $1,638,817 and $1,839,283 for the three months ended March 31, 2016 and 2015, respectively.

 

 13 

 

 

NOTE H - DEFERRED TAX ASSETS 

 

Deferred tax assets consisted of the following as of March 31, 2016 and December 31, 2015:

 

   March 31,   December 31, 
   2016   2015 
Deferred tax assets - current          
Allowance for doubtful accounts  $2,407,989   $1,860,379 
Revenue (net of cost)   62,060    45,815 
Unpaid accrued expenses   145,979    180,174 
Warranty   890,786    875,751 
Deferred tax assets   3,506,814    2,962,119 
Valuation allowance         
Net deferred tax assets - current  $3,506,814   $2,962,119 
           
Deferred tax liabilities - current          
Others  $   $52,390 
Deferred tax liabilities - current  $   $52,390 
           
Net deferred tax assets - current  $3,506,814   $2,909,729 

 

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 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 March 31, 2016 and December 31, 2015:

 

   March 31,   December 31, 
   2016   2015 
           
Secured  $17,447,655   $23,367,207 

 

The Company obtained those short term loans from Bank of China, Bank of Ningbo, China Construction Bank and Agricultural Bank of China, respectively, to finance general working capital as well as new equipment acquisition. Interest rate for the loans outstanding during the three months ended March 31, 2016 ranged from 1.33% to 5.35% per annum. The maturity dates of the loans existing as of March 31, 2016 ranged from April 12, 2016 to January 21, 2017. As of March 31, 2016 and December 31, 2015, the Company's accounts receivables of $7,681,558 and $15,836,158, respectively, were pledged as collateral under loan arrangements. The interest expense for short-term bank loans were $75,698 and $27,291 for three months ended March 31, 2016 and 2015, respectively.

 

As of March 31, 2016, corporate or personal guarantees provided for those bank loans were as follows:

 

$1,547,700   Pledged and guaranteed by Ruili Group, a related party, with its land and buildings.
$12,884,911   Guaranteed by Ruili Group, a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders.
$3,015,044   Guaranteed by Ruili Group, a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders and Jia Rui Zhang, the daughter of Mr. Xiao Ping Zhang and Ms. Shu Ping Chi.

 

 14 

 

 

NOTE J – CAPITAL LEASE OBLIGATIONS

 

   March 31,   December 31, 
   2016   2015 
Total capital lease obligations  $2,653,200   $3,519,949 
Less: current portion   (2,653,200)   (3,519,949)
Non-current portion  $-   $- 

 

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 lease inception date of the new lease agreement is January 4, 2013 and the termination date is January 4, 2017. 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 RMB91,428,571 (approximately $14,545,950) and the Company is required to maintain a security deposit of RMB 11,428,571 (approximately $1,818,244). The Company prepaid all interests of RMB 10,705,357 (approximately $1,703,212) after the discount and is obligated for the payment of RMB 1,904,761.9 (approximately $303,041) monthly. The prepaid interest for capital lease obligation is amortized over the life of capital lease agreement using the effective interest method.

 

NOTE K - INCOME TAXES

 

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

 

In 2009, the Joint Venture was awarded the Chinese government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate for years 2009 through 2011. In 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 continued to be taxed at a 15% rate in 2012 through 2014. The Company used a tax rate of 25% for the first three quarters of 2015. In the fourth quarter of 2015, the Joint Venture passed the re-assessment by the government, based on PRC income tax laws. Accordingly, it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017. The current income tax rate used by the Company for the three months ended March 31, 2016 is 15%.

 

 15 

 

 

The reconciliation of the effective income tax rate of Ruian to the statutory income tax rate in the PRC for the three months ended March 31, 2016 and 2015 is as follows:

 

   Three Months Ended
March 31, 2016
   Three Months Ended
March 31, 2015
 
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%
Valuation allowance recognized with respect to the loss in the HK company   -    -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 R&D expenses   -29.48%   -5.10%
Expenses not deductible for tax purpose   6.63%   3.86%
Effective tax rate   -7.85%   23.76%

 

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. 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, 2015. In the three months ended March 31, 2016 and 2015, there were no penalties and interest, which generally are recorded in the general and administrative expenses or in the tax expenses. The provisions (benefit) for income taxes for the three months ended March 31, 2016 and 2015, respectively, are summarized as follows:

 

   Three Months Ended
March 31, 2016
   Three Months Ended
March 31, 2015
 
Current  $561,978   $1,161,153 
Deferred   (596,802)   (162,875)
Total  $(34,824)  $998,278 

 

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 March 31, 2016 and December 31, 2015.

 

NOTE L – NON-CONTROLLING INTEREST IN SUBSIDIAIRES

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest, owned by Ruili Group Co., Ltd., in Ruian, and a 40% non-controlling interest, owned by the Company’s Joint Venture Partners, in SIH. On December 15, 2015, the Company disposed of its entire 60% equity interest in SIH. The non-controlling interest in SIH was fully removed. The results of SIH disposed of are included in the consolidated statements of income up to the effective date of disposal. Net income attributable to non-controlling interests in subsidiaries amounted to $47,849 and $152,243 for the three months ended March 31, 2016 and 2015, respectively.

 

   March 31, 2016   March 31, 2015 
10% non-controlling interest in Ruian  $47,849   $350,927 
40% non-controlling interest in SIH       (198,684)
           
Total  $47,849   $152,243 

 

 16 

 

 

NOTE M – OPERATING LEASES WITH RELATED PARTIES

 

In December 2006, Ruian entered into a lease agreement with Ruili Group Co., Ltd. for the lease of two apartment buildings. These two apartment buildings are for Ruian’s management personnel and staff, respectively. The lease term is from January 2013 to December 2016. This lease was amended in 2013 with a new lease term from January 1, 2013 to December 31, 2022. The annual lease expense is RMB2,100,000 (approximately $333,688).

 

In May 2009, Ruian entered into a lease agreement with Ruili Group Co., Ltd. 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 Co., Ltd., under which Ruian leased 89,229 square meters manufacturing plant for its new purchased passenger vehicles brake systems business. The lease term is from September 2009 to August 2020. This lease was amended in 2013. The amended lease term is from January 1, 2013 to December 31, 2017. The annual lease expense is RMB8,137,680 (approximately $1,293,070). The lease will be terminated upon the completion of the purchase of the leased properties incurred in the period subsequent to March 31, 2016. See Note Q for details.

 

The lease expenses were $422,611 and $417,483 for the three months ended March 31, 2016 and 2015, respectively.

 

NOTE N - WARRANTY CLAIMS

 

Warranty claims were $495,385 and $485,334 for the three months ended March 31, 2016 and 2015, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The movement of accrued warranty expenses for the three months ended March 31, 2016 was as follows:

 

Beginning balance at January 1, 2016  $5,838,343 
Aggregate increase for new warranties issued during current period   495,385 
Aggregate reduction for payments made   (446,510)
Ending balance at March 31, 2016  $5,887,218 

 

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. Before the disposal of SIH, the Company also had long-lived assets located in Hong Kong. The Company and its subsidiaries do not have long-lived assets in the United States for the reporting periods.

 

 17 

 

 

   Three Months Ended March 31, 
   2016   2015 
         
NET SALES TO EXTERNAL CUSTOMERS          
Commercial vehicles brake systems  $44,080,072   $43,253,546 
Passenger vehicles brake systems   9,756,656    8,944,420 
           
Net sales  $53,836,728   $52,197,966 
INTERSEGMENT SALES          
Commercial vehicles brake systems  $   $ 
Passenger vehicles brake systems        
           
Intersegment sales  $   $ 
GROSS PROFIT          
Commercial vehicles brake systems  $11,960,732   $11,378,176 
Passenger vehicles brake systems   2,478,347    2,352,898 
Gross profit  $14,439,079   $13,731,074 
Selling and distribution expenses   5,562,432    5,350,998 
General and administrative expenses   6,929,858    2,719,372 
Research and development expenses   1,743,687    1,712,621 
           
Other operating income   914,205    585,717 
           
Income from operations   1,117,307    4,533,800 
           
Interest income   88,102    110,955 
Government grants   4,757    25,980 
Other income   45,589    67,411 
Interest expenses   (174,460)   (166,656)
Other expenses   (637,629)   (370,688)
Income before income tax expense  $443,666   $4,200,802 
           
CAPITAL EXPENDITURE          
Commercial vehicles brake systems  $1,021,063   $712,065 
Passenger vehicles brake systems   225,961    147,248 
           
Total  $1,247,024   $859,313 
           
DEPRECIATION AND AMORTIZATION          
Commercial vehicles brake systems  $1,419,696   $1,605,137 
Passenger vehicles brake systems   314,178    331,927 
           
Total  $1,733,874   $1,937,064 

 

 18 

 

 

   March 31, 2016   December 31, 2015 
     
TOTAL ASSETS          
Commercial vehicles brake systems  $259,738,759   $261,924,719 
Passenger vehicles brake systems   57,480,048    58,629,337 
           
Total  $317,218,807   $320,554,056 

 

   March 31, 2016   December 31, 2015 
     
LONG LIVED ASSETS          
Commercial vehicles brake systems  $42,620,352   $42,961,388 
Passenger vehicles brake systems   9,431,861    9,616,495 
           
Total  $52,052,213   $52,577,883 

 

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 located at No. 1169 Yumeng Road, Rui’an Economic Development Zone, Rui’an City, Zhejiang Province, the People’s Republic of China (the “Dongshan Facility”) 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 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 $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. Also see Note Q.

 

(2)The information of lease commitments is provided in Note J and Note M.

 

(3)The information of guarantees and assets pledged is provided in Note D.

 

 19 

 

 

Note Q – SUBSEQUENT EVENTS

 

On May 5, 2016, the Company entered into a Purchase Agreement (the “Purchase Agreement”) with the Ruili Group through Ruian, a related party under common control, pursuant to which the Company agreed to purchase the land use rights and factory facilities located at No. 2666 Kaifaqu Avenue, Rui’an Economic Development Zone, Rui’an City, Zhejiang Province, the People’s Republic of China (the “Development Zone Facility”). In exchange for the Development Zone Facility, the Company will transfer to the Ruili Group the land use rights and factory facilities of the Dongshan Facility that Ruian currently owns, plus RMB501,000,000 (approximately $77,540,000) in cash. The total floor areas of the Dongshan Facility and the Development Zone Facility are 58,714 square meters and 157,619 square meters, respectively.

 

The cash consideration in the amount of RMB481,000,000 (approximately $74,444,000) will be paid to the Ruili Group before June 30, 2016, and the remaining RMB20,000,000 (approximately $3,096,000) will be paid within 10 days of completion of the required procedures for transferring the title of the facilities and the land use right as specified in the Purchase Agreement.

 

The Company is currently leasing 89,229 square meters of the Development Zone Facility from Ruili Group for its brake systems business, which lease will expire on December 31, 2017. This lease will be terminated upon the completion of the purchase.

 

The transaction was approved by a committee of independent directors of the Company based on the valuation reports of a third party real estate appraisal firm.

 

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, 2015, 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 of automotive brake systems in China for commercial vehicles such as trucks and buses.

 

 20 

 

 

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, 2015.

 

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

 

The following statements are about results of operations for the three months ended March 31, 2016 as compared to the three months ended March 31, 2015.

 

Sales

 

   Three Months Ended   Three Months Ended 
   March 31, 2016   March 31, 2015 
   (U.S. dollars in millions)
Commercial vehicle brake systems  $44.0    82%  $43.3    83%
Passenger vehicle brake systems  $9.8    18%  $8.9    17%
                     
Total  $53.8    100%  $52.2    100%

 

The sales were $53,836,728 and $52,197,966 for the three months ended March 31, 2016 and 2015, respectively, an increase of $1.6 million or 3.1%. The increase was mainly due to the increased sales of commercial vehicle brake systems to China OEM and aftermarket market.

 

The sales from commercial vehicle brake systems increased by $0.7 million or 1.6%, to $44.0 million for the first fiscal quarter of 2016, compared to $43.3 million for the same period of 2015. Our high quality, low cost products continued to generate higher sales and further penetrated into the commercial vehicle market, which impacted the sales of the commercial vehicle brake systems.

 

The sales from passenger vehicle brake systems increased by $0.9 million or 10.1%, to $9.8 million for the first fiscal quarter of 2016, compared to $8.9 million for the same period of 2015. The increase was mainly due to the increase of passenger vehicle market in the first fiscal quarter of 2016.

 

 21 

 

 

A breakdown of net sales revenue for these markets for the first fiscal quarter of the 2016 and 2015, respectively, is set forth below:

 

   Three
Months
   Percent   Three
Months
   Percent     
   Ended   of   Ended   of     
   March 31,
2016
   Total
Sales
   March 31,
2015
   Total
Sales
   Percentage
Change
 
   (U.S. dollars in millions)     
China OEM market  $28.1    52.3%  $25.9    49.7%   8.9%
China aftermarket  $13.2    24.5%  $12.4    23.7%   6.5%
International market  $12.5    23.2%  $13.9    26.6%   -10.1%
Total  $53.8    100.0%  $52.2    100.0%   3.3%

 

Considering the increase of the production and sales of the trucks for the first fiscal quarter of 2016 in the automobile industry, our sales to the Chinese OEM Market increased by 8.9% from the first fiscal quarter of 2015, to $28.1 million for the first fiscal quarter of 2016.

 

Our sales to the China aftermarket increased by $0.8 million or 6.5%, to $13.2 million for the first fiscal quarter of 2016, compared to $12.4 million for the same period of 2015. The increased new vehicle sales in China and the expiration of OEM warranties helped to drive our aftermarket business. Sales of our new model products, applicable to both the Chinese OEM Market and Chinese Aftermarket, also increased during the three months ended March 31, 2016. 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 decreased by $1.4 million or 10.1%, to $12.5 million for the first fiscal quarter of 2016, as compared to $13.9 million for the same period of 2015. 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 March 31, 2016 were $39,397,649 an increase of $0.9 million or 2.4% from $38,466,892 for the same period last year. Our gross profit increased by 5.2% from $13,731,074 for the first fiscal quarter of 2015 to $14,439,079 for the first fiscal quarter of 2016.

 

Gross margin increased to 26.8% from 26.3% for the three months ended March 31, 2016 compared to the three months ended March 31, 2015. The increase was mainly due to increased sales of higher margin products in the first fiscal quarter of 2016. We intend to focus in 2016 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 March 31, 2016 were $32.1 million, an increase of $0.2 million or 2.1% from $31.9 million for the same period last year. The gross profit from commercial vehicle brake systems increased by 5.1% from $11.4 million for the first fiscal quarter of 2015 to $12.0 million for the first fiscal quarter of 2016. Gross margin from commercial vehicle brake systems increased to 27.1% from 26.3% for the three months ended March 31, 2016 compared with 2015. The increase was mainly due to increased sales of higher margin products in the first fiscal quarter of 2016.

 

Cost of sales from passenger vehicle brake systems for the three months ended March 31, 2016 were $7.3 million, an increase of $0.7 million or 29.2% from $6.6 million for the same period last year. The gross profit from passenger vehicle brake systems increased by 5.3% from $2.4 million for the first fiscal quarter of 2015 to $2.5 million for the first fiscal quarter of 2016. Gross margin from passenger vehicle brake systems decreased to 25.4% from 26.3% for the three months ended March 31, 2016 compared with 2015. To strengthen our competitiveness and increase our market share, we started the price promotion in the aftermarket and international market for the three months ended March 31, 2016. The increased labor cost also decreased our gross margin for the three months ended March 31, 2016.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were $5,562,432 for the three months ended March 31, 2016, as compared to $5,350,998 for the same period of 2015, an increase of $0.2 million or 4.0%.

 

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The increase was mainly due to increased freight expense and packaging expense. As the percentage of sales revenue, selling expenses percentage was 10.3% for the three months ended March 31, 2016 and 2015.

 

General and Administrative Expenses

 

General and administrative expenses were $6,929,858 for the three months ended March 31, 2016, as compared to $2,719,372 for the same period of 2015, an increase of $4.2 million or 154.8%. 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 12.9% for the three months ended March 31, 2016, as compared to 5.2% for the same period of 2015.

 

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 first-party development costs. For the three months ended March 31, 2016, research and development expenses were $1,743,687, as compared to $1,712,621 for the same period of 2015, an increase of $31,066.

 

Other Operating Income

 

Other operating income was $914,205 for the three months ended March 31, 2016, as compared to $585,717 for the three months ended March 31, 2015, an increase of $328,488. The increase was mainly due to an increase in sales of raw material scraps for the three months ended March 31, 2016.

 

Depreciation and Amortization

 

Depreciation and amortization expense decreased to $1,733,874 for the three months ended March 31, 2016, as compared to that of $1,937,064 for the same period of 2015, a decrease of $203,191. 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 March 31, 2016.

 

Interest Income

 

Interest income for the three months ended March 31, 2016 decreased by $22,853 to $88,102 from $110,955 for the same period of 2015, mainly due to increased short term investments during the periods.

 

Interest Expenses

 

The interest expenses for the three months ended March 31, 2016 increased by $7,804 to $174,460 from $166,656 for the same period of 2015, mainly due to increased interest rate and increased amount of average loans outstanding during the period.

 

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 Chinese government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate for years 2009 through 2011. In 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 continued to be taxed at a 15% rate in 2012 through 2014. The Company used a tax rate of 25% for the first three quarters of 2015. In the fourth quarter of 2015, the Joint Venture passed the re-assessment by the government, based on PRC income tax laws. Accordingly, it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017.The current income tax rate used by the Company for the three month ended March 31, 2016 is 15%.

 

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Income tax benefit of $34,824 and income tax expense of $998,278 was recorded for the fiscal quarter ended March 31, 2016 and 2015, respectively. The decrease was mainly due to decreased income tax rate and pre-tax income.

 

Net Income Attributable to Non-Controlling Interest in Subsidiaries

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH, in each case held by our joint venture partners. On December 15, 2015, the Company disposed of its entire 60% equity interest in SIH. Net income attributable to non-controlling interest in subsidiaries amounted to $47,849 and $152,243 for the first fiscal quarter ended March 31, 2016 and 2015, respectively.

 

Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the fiscal quarter ended March 31, 2016 decreased by $2.6 million, to $430,641 from $3,050,281 for the fiscal quarter ended March 31, 2015 due to the increase in our general and administrative expenses. Earnings per share (“EPS”), both basic and diluted, for the fiscal quarter ended March 31, 2016 and 2015, were $0.02 and $0.16, respectively.

 

Liquidity and Capital Resources

 

CASH FLOWS

 

As of March 31, 2016, the Company had cash and cash equivalents of $6,103,766, as compared to cash and cash equivalents of $4,727,453 as of March 31, 2015. The Company had working capital of $171,957,417 at March 31, 2016, as compared to working capital of $165,955,674 at March 31, 2015, reflecting current ratios of 2.84:1 and 3.69:1, respectively.

 

OPERATING - Net cash used in operating activities was $410,799 for the three months ended March 31, 2016 compared with $485,517 of net cash used in operating activities in the same period of 2015, a decrease of $0.07 million, primarily due to the increased cash inflow resulted by changes in inventories and accounts payable and bank acceptance notes to vendors.

 

INVESTING - During the three months ended March 31, 2016, the Company expended net cash of $17,372,663 in investing activities, mainly for acquisition of new equipment to support the growth of the business and advance to related party. For the three months ended March 31, 2015, the Company expended net cash of $11,017,028 in investing activities.

 

FINANCING - During the three months ended March 31, 2016, the cash used in financing activities was $7,161,339. The cash provided by financing activities was $2,240,511 for the three months ended March 31, 2015.

 

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 transfer of 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.

 

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OFF-BALANCE SHEET ARRANGEMENTS

 

As of March 31, 2016, 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. In 2007 the Company purchased the land use rights of the Dongshan Facility 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.

 

Even if the Company is unable to timely 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 will have 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$745,220) 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.

 

The Dongshan Facility will be transferred back to the Ruili Group upon the completion of the purchase of the Development Zone Facility incurred in the period subsequent to March 31, 2016. See Note Q for details.

 

CONTRACTUAL OBLIGATIONS

 

As of March 31, 2016, we had no material changes outside the ordinary course of business in our contractual obligations.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable.

 

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 us, including our chief executive officer and chief 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 March 31, 2016 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 March 31, 2016, 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 March 31, 2016 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.

 

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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 Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32 Certification of Chief Executive Officer and Chief 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.

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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 : May 16, 2016 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 Accounting Officer)

 

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