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EX-32 - EXHIBIT 32 - SORL Auto Parts Inctv489554_ex32.htm
EX-31.2 - EXHIBIT 31.2 - SORL Auto Parts Inctv489554_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SORL Auto Parts Inctv489554_ex31-1.htm

 

 

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

 

 

FORM 10-K

 

 

 

þANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended - December 31, 2017

 

OR

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from

 

Commission file number 000-11991

 

SORL AUTO PARTS, INC.

(Name of Registrant in Its Charter)

 

DELAWARE

(State or Other jurisdiction

of Incorporation or Organization)

30-0091294

(I.R.S. Employer Identification No.)

 

NO.2666 KaiFaqu Avenue,

Ruili Industry Area,

RUIAN CITY, ZHEJIANG PROVINCE 325200

PEOPLE’S REPUBLIC OF CHINA

(Address of Principal Executive Offices, Including Zip Code.)

 

86-577-65817720

(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

TITLE OF EACH CLASS

NAME OF EACH

EXCHANGE ON WHICH REGISTERED

COMMON STOCK: $0.002 PAR VALUE NASDAQ GLOBAL MARKET

 

Securities registered pursuant to Section 12(g) of the Act: NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ¨ No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No þ

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 þ 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 þ No ¨

 

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by referenced in Part III of this Form 10-K or any amendment to this Form 10-K. þ

 

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

 

Large accelerated filer ¨   Accelerated filer ¨   Non-accelerated Filer ¨   Smaller Reporting Company þ   Emerging Growth Company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

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

 

Yes ¨ No þ

 

State registrant’s revenues for its most recent fiscal year December 31, 2017: $390,522,569.

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity as of the last business day of registrant’s most recently completed second fiscal quarter. As of June 30, 2017, the value was approximately $53.0 million.

 

State the number of shares outstanding of each of the registrant’s classes of common equity: 19,304,921 shares as of April 2, 2018.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement for its annual meeting of shareholders, which is expected to be filed no later than 120 days after December 31, 2017, are incorporated by reference into Part III Items 10, 11, 12, 13 and of this report.

 

 

 

 

 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this Annual Report on Form 10-K of SORL Auto Parts, Inc., other than historical facts, may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. We intend for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Securities Act and the Exchange Act, as applicable by law. Such statements include, in particular, statements about our plans, strategies and prospects, and are subject to certain risks and uncertainties, as well as known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “would,” “could,” “should,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this Annual Report on Form 10-K is filed with the Securities and Exchange Commission, or SEC. We make no representation or warranty (express or implied) about the accuracy of any such forward-looking statements contained in this Annual Report on Form 10-K, and we do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. We caution investors not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results. The forward-looking statements should be read in light of the risk factors identified in the Item 1A. Risk Factors section of this Annual Report on Form 10-K.

 

 2 

 

 

TABLE OF CONTENTS

 

  PART I  
     
ITEM 1. DESCRIPTION OF BUSINESS 4
     
ITEM 1.A. RISK FACTORS 14
     
ITEM 1B. UNRESOLVED STAFF COMMENTS 24
     
ITEM 2. PROPERTIES 24
     
ITEM 3. LEGAL PROCEEDINGS 24
     
ITEM 4. MINE SAFETY DISCLOSURE 24
     
  PART II  
     
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 25
     
ITEM 6. SELECTED FINANCIAL DATA 25
     
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 26
     
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 33
     
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 34
     
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 64
     
ITEM 9A. CONTROLS AND PROCEDURES 64
     
ITEM 9B. OTHER INFORMATION 65
     
  PART III  
     
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 65
     
ITEM 11. EXECUTIVE COMPENSATION 65
     
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 65
     
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 65
     
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 66
     
  PART IV  
     
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 66
     
SIGNATURES   68

 

 3 

 

  

PART I

 

ITEM 1. DESCRIPTION OF BUSINESS

 

BUSINESS

 

Incorporated on March 24, 1982, SORL Auto Parts, Inc. is a Delaware corporation. Through its 90% ownership of the Ruili Group Ruian Auto Parts Co., Ltd., a Sino-Foreign joint venture (the “Joint Venture”), SORL Auto Parts, Inc. (together with its subsidiaries, “we,” “us,” “our” or the “Company” or “SORL”) develops, manufactures and distributes automotive brake systems and other key safety related auto parts to automotive original equipment manufacturers, or OEMs, and the related aftermarket both in China and abroad. The Company’s products are used in different types of commercial vehicles, such as trucks and buses. Automotive brake systems and other key safety related auto parts are critical components that ensure driving safety.

 

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 (the “JV Agreement”) between the Ruili Group Co., Ltd. (the “Ruili Group”) and Fairford Holdings Limited (“Fairford”), a wholly owned subsidiary of the Company. The Ruili Group was incorporated in China in 1987 and specialized in the development, production and sale of various kinds of automotive parts. Fairford and the Ruili Group contributed 90% and 10%, respectively, of the paid-in capital of the Joint Venture, which totaled $7.1 million.

 

On January 19, 2004 the Joint Venture acquired the business segment of the Ruili Group relating to manufacture and sale of various kinds of valves for automotive brake systems and related operations (the “Transferred Business”). The Ruili Group began its automotive air brake valve business in 1987. The acquisition was accomplished by a transfer from the Ruili Group to Fairford of relevant assets and liabilities of the Transferred Business including trade receivables, inventories and machineries, and the assumption of short and long term borrowings for a purchase price of $6,390,000. The consideration was based on a valuation provided by Ruian Ruiyang Assets Valuation Co., Ltd., an independent PRC valuation firm. Fairford then transferred these assets and liabilities to the Joint Venture as consideration for its 90% ownership interest of the Joint Venture. The Ruili Group transferred inventory as its capital contribution for its 10% interest in the Joint Venture. The assets and liabilities transferred to the Joint Venture by Fairford and the Ruili Group represented all the assets and liabilities of the Transferred Business. Certain historical information of the Transferred Business is based on the operation of the Transferred Business when it was owned by the Ruili Group.

 

On November 30, 2006, the Company completed a follow-on public offering of 4,285,714 shares of common stock at $7.25 per share. Gross proceeds were approximately $31.1 million. Net proceeds after approximately $2.2 million of underwriters’ commissions and approximately $0.7 million of related offering expenses were approximately $28.2 million. On December 13, 2006, Maxim Group LLC, the lead underwriter of offering, exercised its over-allotment option in full to purchase an additional 642,857 shares of common stock. After deduction of underwriter’s discount of approximately $0.3 million, the Company received approximately $4.3 million. The aggregate net proceeds to the Company of this offering were approximately $32.5 million, which included the approximate $4.3 million as a result of the exercise of the over-allotment option granted to the underwriters.

 

On December 8 and 26, 2006, pursuant to the terms of the Joint Venture Agreement, as revised, through Fairford, the Company invested $32.67 million in its operating subsidiary, the Joint Venture. To maintain its 10% interest in the Joint Venture, the Ruili Group increased its capital investment by $3.63 million. Accordingly, the Company continued to hold a 90% controlling interest in the operating subsidiary. Pursuant to the JV Agreement and the Joint Venture Agreement, as revised, the total paid-in capital of the Joint Venture increased from $7.1 million to $43.4 million.

 

 4 

 

 

On November 11, 2009, the Company, through its wholly owned subsidiary, Fairford, entered into a joint venture agreement with MGR, a Hong Kong-based global auto parts distribution specialty firm and an unaffiliated Taiwanese individual investor. The new joint venture was named SORL International Holding, Ltd. ("SIH") based in Hong Kong. Fairford holds a 60% interest in SIH, MGR holds a 30% interest, and the Taiwanese individual 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 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 individual investor for US$77 (HK$600), and the share transfer was approved by the Hong Kong authorities on January 14, 2016. After this transaction, SIH ceased to be a distributor of SORL in the international market.

 

On February 8, 2010, the Company sold 1,000,000 shares of its common stock to selected institutional investors at a price of $10.00 per share pursuant to a registered direct offering. This transaction provided net proceeds of approximately $9.4 million. On March 9, 2010, through Fairford, SORL invested approximately $9.4 million in its operating subsidiary, the Joint Venture. To maintain its 10% interest in the Joint Venture, the Ruili Group increased its capital investment by approximately $1.0 million. Accordingly, SORL continues to hold a 90% controlling interest in the operating subsidiary. The total paid-in capital of the Joint Venture increased from $43.4 million to $53.8 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 RMB170 million, or approximately $25 million. The transaction was accounted for using the book basis 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, accounts receivable at book values of $8.0 million, $8.0 million and $5.2 million, respectively. The Company did not acquire any of the assets of the Ruili Group other than as described above. The excess of consideration over the carrying value of net assets received has been recorded as a decrease in the additional paid-in capital of the Company.

 

The Company accounted for the acquisition as a transaction between the entities under common control because Mr. Xiao Ping Zhang, the Chairman and CEO of the Company owns 63% of the registered capital of the Ruili Group, and, together with his wife (Ms. Shu Ping Chi) and brother (Mr. Xiao Feng Zhang), owns approximately 58.8% 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.

 

On October 30, 2015, Mr. Xiao Ping Zhang, the Chairman and CEO of the Company, together with his wife (Ms. Shu Ping Chi) and brother (Mr. Xiao Feng Zhang) (collectively, the “Consortium”) submitted a non-binding proposal (the “Proposal”) to the board of directors of the Company proposing to acquire all of the outstanding shares of the Company’s common stock not already owned by the Consortium at a price of $2.84 per share in cash and if successful in that acquisition, to cause the Company’s common stock to be delisted from NASDAQ and to be deregistered under the Securities Exchange Act of 1934, as amended. The board of directors subsequently formed a special committee (the “Special Committee”) consisting of independent directors to evaluate the Proposal. On January 8, 2016, the Consortium sent a letter to the Special Committee withdrawing the Proposal citing concerns over recent market conditions.

 

On May 5, 2016, through its principal operating subsidiary, the Company entered into a Purchase Agreement (the “Purchase Agreement”) with the Ruili Group, 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 agreed to transfer to the Ruili Group the land use rights and factory facilities of the Dongshan Facility owned by the company, plus RMB501,000,000 (approximately $76,533,000) in cash.

 

 5 

 

 

The cash consideration in the amount of RMB481,000,000 (approximately $73,478,000) was paid to the Ruili Group in installments before June 30, 2016, and the remaining RMB20,000,000 (approximately $3,016,000) 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. Before the transaction, the Company was leasing 89,229 square meters of the Development Zone Facility from Ruili Group for its brake systems business, which lease was scheduled to expire on December 31, 2017. This lease was 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 real estate appraisal firm.

 

STRATEGIC PLAN

 

With the implementation of the Chinese IV Emission Standard, large quantities of used vehicles could not reach the standard requirements and were determined to be replaced, which contributed to substantial increase in auto parts sales for 2017. Additionally, in 2017, the Chinese government strictly enforced the rule that vehicles must not be overloaded above weight limits, which resulted in higher demands in new vehicles that are capable of loading larger weight limits. The higher demands lead to increased sales in auto parts. In 2017, the Company expects the aforementioned law enforcements of emission standards and weight limits will continue to boost the needs in auto parts until demands of new vehicles are saturated. In 2018, the Chinese Central Government will still strengthen the actions to control the excess emission of the diesel vehicle and also include the New Energy Vehicle development as one of its essential works. Based on the above analysis, the management projects the commercial vehicle market will have a slight increase in 2018. In 2018, our strategic plan includes these elements:

 

·Enhance the development of new energy products. The management projects that the New Energy Vehicle market will have a moderate growth in 2018.

 

·Improve manufacturing technology and further computerize our manufacturing processes. We plan to continue improving our manufacturing process to enhance product quality. We believe that improvement of manufacturing technology will further automate and streamline our manufacturing processes, which could ultimately eliminate human errors, increase manufacturing efficiency, lower production costs and at the same time ensure consistent quality of our products.

 

THE COMPANY’S PRODUCTS

 

Through the Joint Venture, the Company manufactures and distributes automotive brake systems and other key safety related auto parts in China and internationally. Our products are mainly used in the braking systems of different types of commercial vehicles, passenger vehicles and railway transportation vehicles, including an extensive range of products covering 65 categories and over 2,000 specifications in automotive brake systems. Automotive brake systems and other key safety related auto parts are essential components to ensure driving safety.

 

We seek to introduce new products for each customer. When working with a customer, our goal is to understand the need of each customer and utilize our extensive experience and innovative technology to deliver products that meet such need. We support our products with a full range of styling, design, testing and manufacturing capabilities, including just-in-time and in-sequence delivery.

 

ISO 9000 is a family of standards related to quality management systems and designed to help organizations ensure that they meet the needs of customers and other stakeholders. The standards are published by ISO, the International Organization for Standardization, and available through national standards bodies. ISO 9001 deals with the requirements that organizations wishing to meet the standard have to fulfill.

 

 6 

 

 

OHSAS 18001 is an Occupation Health and Safety Assessment Series for health and safety management systems. It is intended to help organizations to control occupational health and safety risks. It was developed in response to widespread demand for a recognized standard against which health and safety management systems are to be certified and assessed.

 

The Company obtained ISO9001/QS9000/VDA6.1 System Certifications in 2001. We passed the ISO/TS 16949 System Certification test (an ISO technical specification aiming to develop a quality management system which provides for continued improvement, emphasizing defect prevention and the reduction of variation and waste in the supply chain) conducted by the TUV CERT Certification Body of TUV Industries Service GmbH in 2004, and its annual review in 2015. The ISO/TS 16949 System, a higher standard replacing the ISO9001/QS9000/VDA6.1 System, was enacted by the International Automotive Task Force and is recognized by major automobile manufacturers all over the world. The annual reviews for other certifications which we passed include ISO14001 on environmental management and OHSAS18001 for health and safety management, reflecting the Company’s commitment to workplace safety, health and environmental protection.

 

CHINA AUTOMOBILE AND AUTO PARTS INDUSTRY

 

Based on statistics published by the China Association of Automobile Manufactures (“CAAM”) in 2017, China currently is still the world’s biggest automotive market and continued to expand, hitting an all-time high in 2017. The automobile industry is one of China’s key industries, contributing significantly to the growth of China’s economy.

 

According to the statistics published by the CAAM in 2017, China’s automobile output and sales volume both reached high record levels of 29.01 million and 28.88 million units, respectively, representing increases of 3% and 3.2% respectively comparing to 2017. The output and sales volume of commercial vehicles increased by 13.8% to 4.20 million units and 14% to 4.16 million units, respectively.

 

The Chinese auto parts industry is highly fragmented. Management believes that the future development areas of China’s auto parts industry will likely include:

 

·To keep pace with the rapid development of new automobile technologies.
·To meet the requirements of increasingly demanding OEM customers, such as zero defects, and cost reduction.
·To partner with OEM customers in the entire process from product design, development and production to cost control, quality control and final delivery.
·To restructure the industry and form large auto parts manufacturing groups which will enhance the overall competitiveness of Chinese auto parts manufacturers when competing with leading international manufacturers.

 

MARKETS AND CUSTOMERS

 

We strengthened our sales and marketing efforts in 2017. The sales person headcounts for Chinese sales and international sales were 105 and 70, respectively. Products are sold under the “SORL” trademark, which we licensed on a royalty free basis from Ruili Group. The Company renewed the license from Ruili Group in 2012 which currently expires in 2022. We have an agreement with Ruili Group that the term of the license will be extended beyond 2022 as long as the registration for the trademark is renewed.

 

In general, The Company’s sales can be divided into three segments: Chinese OEM Market, Chinese Aftermarket, and International Market. The above identified markets account for approximately 46.1%, 35.4% and 18.5%, respectively, of the Company’s annual sales for 2017.

 

Chinese OEM Market - We have established long-term business relationships with most of the major vehicle manufacturers in China. We sell our products to approximately 70 major vehicle manufacturers, including a majority of the key truck manufacturers in China. In addition to heavy-duty trucks, our products are also widely used in brake systems on buses. Typically, bus manufacturers purchase a chassis from truck chassis manufacturers which already has incorporated our brake systems.

 

 7 

 

 

The table below presents comparative information for 2017 and 2016 of the Company’s top five OEM customers.

 

Ranking  Customer 

% of

2017

Sales

   Customer 

% of

2016

Sales

 
               
1  FAW Jiefang Automotive Co., Ltd.   5.0%  FAW Jiefang Automotive Co., Ltd.   4.8%
2  FAW Jiefang Qingdao Automotive Co., Ltd.   3.5%  FAW Jiefang Qingdao Automotive Co., Ltd.   3.2%
3  Shaanxi Heavy Duty Automobile Co., Ltd.   3.3%  Shaanxi Heavy Duty Automobile Co., Ltd.   2.6%
4 

Dongfeng Dena Axle Co., Ltd.(Shi Yan)

   1.8%  Anhui Jianghuai Automobile Co., Ltd.   2.1%
5  Beijing Foton Daimler Automotive Co., Ltd.   1.8% 

Dongfeng Dena Axle Co., Ltd.(Shi Yan)

   2.0%

 

We continue to expand our business with FAW Group, Dongfeng Motor Co., Ltd, and Shaanxi Heavy Duty Automobile Co., Ltd, which ranked in the top ten highest sales commercial vehicle manufacturers in China during 2017. The Company is a “core supplier” to the FAW Group, and a strategic partner with both Beiqi Foton Motor Co., Ltd., and Dongfeng Motor Co., Ltd. (through product co-development contracts and priority supply agreements).

 

Chinese Aftermarket - The Company’s Chinese aftermarket sales network consists of 56 authorized distributors covering the following seven regions throughout China: Northeast Region, North Region, Northwest Region, Southwest Region, Central Region, East Region and South Region.

 

The 56 authorized distributors sell only “SORL” products and further distribute the products through over 2,000 sub-distributors.

 

International Market – With incline in the truck production and currency depreciation in some countries in 2017, our export sales in 2017 increased comparing to 2016. Our strategies in the export market include the following:

 

·We focus on both the international aftermarket and OEM customers at the same time.
·The Company also actively participates in international trade shows including more than ten international exhibitions such as Automechanika in Frankfurt, Equip Auto in Paris, Automotive Aftermarket Products Expo in Las Vegas, Automechanika Middle East in Dubai and China Import and Export Fair in Guangzhou, to attract new customers and new orders.
·In December 2015, we divested all of our equity interest in SORL International Holding, Ltd., a joint venture we formed in 2009 in Hong Kong. Going forward, we plan to distribute our products in the Asia-Pacific region primarily through our in-house sales teams.
·The Company strives to create a larger footprint in Europe, the Middle East and Africa with a target to create a truly global distribution network. The Company presently has international sales centers in the United Arab Emirates (“UAE”), the United States of America (“USA”), and Europe. They carry out localization strategies to meet the different market demands and to strengthen service support.

 

 8 

 

 

In 2017, our export sales accounted for 18.5% of total revenue. Products are exported to more than 104 countries and regions in the world. The table below presents comparative information for 2017 and 2016 of the Company’s top five international customers.

 

Ranking    Country   Customer Name  % of
2017
Sales
     Country   Customer Name  % of
2016
Sales
 
                       
1   USA   SAP   2.4%   USA   SAP   2.4%
2   

UAE

 

   GOLDEN DRAGAN AUTO SPARE PARTS   1.0%   India   HISHIKHA OVERSEAS   1.6%
3   India   HISHIKHA OVERSEAS   1.0%   

UAE

   GOLDEN DRAGAN AUTO SPARE PARTS   1.4%
4   USA  

Alltech Auto

   0.8%   USA   CARDONE   0.9%
5   BRAZIL   SCHULZ   0.8%   USA  

Alltech Auto

   0.8%

 

COMPETITION

 

We conduct our business in a complex and highly competitive industry. The global automotive parts industry principally involves the supply of systems, modules and components to vehicle manufacturers for the manufacture of new vehicles. Additionally, suppliers provide parts to other suppliers for use in the latter’s product offerings and to the aftermarket for use as replacement or enhancement parts for older vehicles. Currently, vehicle manufacturers generally only engage in assembling but not manufacturing non-key automotive parts. Rather, they source these parts through a global network of suppliers. As a result, only those automotive parts manufacturers with large-scale production capacity, advanced technology and the ability to produce system and modules can supply their products to vehicle manufacturers directly. The automotive parts industry in China is fragmented and there are many small manufacturers who mainly target at the aftermarket. However, there are not many companies which have established both nationwide aftermarket sales networks and close relationships with leading OEM manufacturers. As the largest commercial vehicle air brake system manufacturer (by sales volume) in China, we have established long-term business relationships with many major automotive manufacturers in China, such as FAW Group (a.k.a. First Auto Group), Dongfeng Motors Group, Beiqi Foton Motor Co., Ltd., Baotou North-Benz Heavy Duty Truck Co., Ltd. and Anhui Jianghuai Automobile Co., Ltd. The management believes that the keys for being a successful commercial vehicle air brake supplier are product quality, price competitiveness, development capability, new product development capacity, and timely delivery. We have strived to improve our competitiveness by recruiting highly qualified managers and employees, improving our product design capability and facilities, and providing better customer services.

 

Domestic Competition - Our major competitors in China are: VIE and CAFF, each as described below.

 

·China VIE Group, or VIE: Its principal products are main valves and unloader/governors, majorly supplied to OEMs, such as Anhui Jianghuai Automobile Co., Ltd., and the remaining portion supplied to the aftermarket and export.

 

·Chongqing CAFF Automobile Braking and Steering Systems Co., Ltd., or CAFF: Its main products are air dryers and main valves. Its principal customer is Chongqing Heavy Vehicle Group Co., Ltd.

 

 9 

 

 

We believe the Company has the following competitive advantages:

 

·Brand Name: As one of China’s largest (by sales volume) commercial vehicle air brake systems manufacturer, our “SORL” brand is known nationwide. SORL was awarded as the “Well-Known Brand” issued by Chinese State Administration of Industry and Commerce.
·Technology: We take technological innovation and leadership as the critical path to enhance our core competence. Our technology center includes a laboratory specializing in the research of automotive brake controlling technologies and development of air brake system products. We have also established a new state-of-the-art testing center in 2014, which strengthened our testing capability.
·Product Development: Because our management has the belief that our products ultimately define our success, we continue to increase our budget for research and development activities. Through our international sales offices in the US, the Middle East and Europe we are able to promptly collect information about current trends in automotive technologies, which in turn is applied to our new product development and used to enhance our ability to provide domestic OEMs with advanced products. In addition, our software systems and strict implementation of ISO/TS16949 standards in the development process greatly shorten our development lead time and improve new product quality. The Company has developed its own independent intellectual property embedded in its air brake spring chambers. The spring chamber’s structure, performance, and quality have made it one of the Company’s key products and it enjoys a great deal of success among domestic auto manufacturers.
·China Sales Networks: We have 56 authorized distributors covering seven regions in China. We help train their salesperson and improve their service quality. These authorized distributors in turn distribute “SORL” products through over 2,000 sub-distributors throughout China.

 

International Competition - In the international market, our largest competitors are Wabco Holdings, Inc. and Knorr-Bremse Group. While management believes our current advantage over Wabco Holdings, Inc. and Knorr-Bremse Group is our lower pricing, management also believes that the Company’s product quality and brand awareness are improving. Our competitive advantages over other competitors in the global market are:

 

·Performance-Cost Ratio: Our products enjoy lower production costs due to the low labor costs in China. The Company’s technology and manufacturing improvements have strengthened and our products’ performance-cost ratio is increasing.
·Quick Adaptation to Local Markets: Through our international sales channels in the U.S., the Middle East and Europe, we have been able to timely respond to local market needs.
·Diversified Auto Products: In addition to braking system products for commercial vehicles, we also produce key safety products for passenger vehicles and braking system products for railway vehicles. This integrated product offering helps reduce customers’ transaction costs and incentives the customers to purchase such products from us.

 

INTELLECTUAL PROPERTY AND INNOVATION CAPACITY

 

As of December 31, 2017, we had 370 technical staff members, 210 of whom possess Engineer or Senior Engineer qualifications. Our technical staff are divided as follows: 30 for information technology, 230 for new product development and design techniques, 35 for measurement and testing, and the remaining 75 for quality management.

 

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Besides our own technical force, we also have cooperation arrangements with leading universities in the automotive engineering field, including:

 

·In 2010, SORL created two new post-doctoral research programs. The first program is a partnership with the Automobile Institute of Jilin University. This program was established to conduct research on the recovery of electric vehicle braking energy. The second program is a partnership with the Beijing University of Technology. This program was established to conduct researches on die-casting aluminum oxide film onto auto parts.
·We have contracts with both Tongji University at Shanghai and Harbin Institute of Technology for co-development of electronically controlled braking systems and automotive master cable technology.
·We have contracts with both Tsinghua University E-Tech Technology Co., Ltd. and Zhejiang University for information technology projects, including the development of application software for product design innovation and production management.

 

We have priority rights to acquire the intellectual properties that are developed pursuant to the arrangements with these universities. The financial arrangements as to amount and terms of payment vary depending on the type of project. Normally, we make an initial payment in the form of a research grant and then negotiate a payment schedule based upon development of the technology.

 

We also consult with the technical staff of the Ruili Group from time to time at a no-cost basis. We have collaborated with other industry research groups, such as the research centers of FAW Group and Dongfeng Group.

 

We own a full range of processing equipment required for the development of new auto part products, including machines for molding, die casting, cutting, pressing and surface treatment. Furthermore, we are capable of designing and making over 90% of the devices, such as tools, jigs and molds, that are required for producing prototypes. Last but not the least, the partnerships with Tsinghua University and Zhejiang University in developing software for application in our new product design system have leaded to substantial time savings in our new product development cycle.

 

Patented Technologies

 

We continue to invest in research and development (“R&D”) efforts and to pursue patent protection. Currently we own 617 issued patents and 745 patent applications worldwide.

 

Trademarks

 

Our principal trademark is “SORL”, which we currently licensed on a non-exclusive royalty free basis from the Ruili Group. The license currently expires in the year of 2022 and we have an agreement with the Ruili Group that the term of the license will be extended as long as the registration for the trademark is renewed. The Ruili Group obtained the registration for “SORL” from the World Intellectual Property Organization and registered the trademark in the United States in 2007 as well.

 

PRODUCTION

 

Our production processes include fixture, jig and die making, aluminum alloy die casting, metal sheet stamping, numerical control cutting, welding, numerical control processing, surface treatment, filming, rubber/plastic processing, final assembly and packaging. We have state-of-the-art manufacturing and testing facilities sourced from the U.S., South Korea, Taiwan and mainland China, including computerized numerical control processing centers, computerized numerical control lathes, casting, stamping and cutting machines, automatic spraying and electroplating lines, cleaning machines, automatic assembly lines and three-dimensional coordinate measuring machines and projectors. We are seeking to realize automation to reduce production cost. 

 

ENVIRONMENTAL COMPLIANCE

 

The Company is subject to the applicable requirements of U.S. federal, state, local and non-U.S. authorities, including China’s, environmental and occupational safety and health laws and regulations. These include laws regulating air emissions, water discharge and waste management. The Company has an environmental management structure designed to facilitate and support its compliance with these requirements globally. Although the Company intends to comply with all such requirements and regulations, it cannot assure that it is at all times in compliance. The Company has made and will continue to make capital and other expenditures to comply with environmental requirements, although such expenditures were not material during the past two years. Environmental requirements are complex, change frequently and have the tendency to become more stringent over time. Accordingly, the Company cannot assure that environmental requirements will not change or become more stringent over time or that its environmental cleanup costs and liabilities will not be material.

 

In 2006, we were granted ISO14001 certification on environmental management (ISO 14000 is a family of standards related to environmental management that exists to help organizations minimize the negative impact of their operations on the environment and comply with applicable environmental laws, regulations, and rules) and OHSAS18001 certification on health and safety management, which reflects the Company’s commitment to workplace safety, health and environmental protection. We conduct staff training to enhance awareness of environmental issues. We seek in all phases of our operations to employ practices for environment friendly production, reduction or prevention of pollution, and reduction of energy consumption and manufacturing costs. For example, noise intensity is listed as one of the criteria in the selection of new equipment; waste water is stored, purified and recycled in the production processes; and compressing machines are used in the disposal of aluminum and steel scraps, saving both storage space and power consumption.

 

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During 2017, the Company did not make any material capital expenditures relating to environmental compliance.

 

RAW MATERIALS

 

Raw materials used by the Company in the manufacture of our products primarily include steel, aluminum, other metals, rubber and various manufactured components.

 

All of the materials we use generally are readily available from numerous sources. We have not, in recent years, experienced any significant shortages of manufactured components or raw materials, and we normally do not carry inventories of these items in excess of what are reasonably required to meet our production and shipping schedules. Critical raw materials are generally supplied from at least two or more vendors to assure adequate supply and reasonable price. We maintain relationships with over twenty material suppliers. In 2017, our three largest suppliers were Shanghai Shougang Steel Trading Co., Ltd., Shanghai Bao Steel Trading Co., Ltd., and Shanghai Jin Shi Material Trading Co., Ltd. which together accounted for 11.7% of the total purchase. None of the suppliers accounted for more than 10% of the total purchases.

 

When planning a purchase order, we compare prices of comparable goods quoted by different suppliers to receive the lowest price. In order to secure a favorable purchase price and subsequently a predictable cost of sales, we generally make a down payment to suppliers.

 

Normally, our annual purchase plan for raw materials, such as aluminum ingot and steel sheet, are determined at the beginning of the calendar year according to our OEM customers’ orders and our own forecast for the aftermarket and international sales. Our purchase plans with key suppliers can be revised quarterly. Our actual requirements are based on monthly production plans. Management believes that this arrangement prevents us from having excessive inventories when the orders from our customers change.

 

For raw materials, other than steel and aluminum, we generally maintain from five to seven days of inventory at our warehouse.

 

RESEARCH AND DEVELOPMENT

 

The Company believes that its engineering and technical expertise, together with its emphasis on continuing research and development, allow it to use the latest technologies, materials and processes to solve problems for its customers and bring new, innovative products to market. The Company believes that continued research and development activities, including engineering, are critical to maintain its pipeline of technologically advanced products.

 

DOING BUSINESS IN CHINA

 

China’s Economy

 

Management believes that an important factor that affects the Chinese automobile industry is the country’s economic environment. According to China’s Statistics Bureau, China’s economic growth slowed down during the last three years, with a GDP growth rate for 2015, 2016 and 2017, of 6.9%, 6.7% and 6.9%, respectively.

 

The Chinese Legal System

 

The practical effect of the legal system in China on our business operations can be viewed from two separate but intertwined considerations. First, as a matter of substantive law, the laws regarding foreign invested enterprises provide significant protection against government interference. In addition, these laws to a large extent protect the full enjoyment of the benefits of corporate organizational documents and contracts to foreign invested enterprise participants. These laws, however, do impose standards concerning corporate formation and governance, which are not qualitatively different from the general corporation laws of the several states of the United States. Similarly, the accounting standards and regulations in China mandate certain accounting practices, which are not consistent with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Chinese accounting standards and regulations require that an annual “statutory audit” be performed in accordance with China’s accounting standards and that the books of account of foreign invested enterprise are maintained in accordance with the Chinese accounting standards and regulations.

 

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Second, while the enforcement of substantive rights may appear less certain or reliable than under the legal system in the United States, foreign invested enterprises and wholly foreign-owned enterprises are Chinese registered companies that enjoy the same legal status as other Chinese registered companies in business-to-business dispute resolutions. Because the terms of the respective Articles of Association of the Joint Venture (“Articles of Association”) provide that all business disputes pertaining to foreign invested enterprises are to be resolved by the Arbitration Institute of the Stockholm Chamber of Commerce in Stockholm, Sweden applying Chinese substantive law, the Chinese minority partner in the Joint Venture should not enjoy a privileged position regarding such disputes. Any award rendered by this arbitration tribunal is, by the express terms of the Articles of Association, enforceable in accordance with the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958). Therefore, as a practical matter, although no assurances can be given, the Chinese legal infrastructure, while different from its United States counterpart, should not present any significant impediment to the operation of foreign invested enterprises.

 

Economic Reform Issues

 

Although the Chinese government controls many productive assets in China, in the past several years the government has implemented economic reform measures which emphasize decentralization and encourage private economic activities. Because these economic reform measures may be inconsistent or ineffectual, there are no assurances that:

 

·We will be able to capitalize on economic reforms;
·The Chinese government will continue its pursuit of economic reform policies;
·The economic policies, even if pursued, will be successful;
·Economic policies will not be significantly altered from time to time; and
·Business operations in China will not become subject to the risk of nationalization.

 

Since 1979, the Chinese government has embarked reforms of its economic structure. Because many reforms are unprecedented or experimental, they are subject to risks and setbacks. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or the disparities in per capita wealth between regions within China, could lead to further adjustment of the reform measures. This refining and adjustment process may negatively affect our operations.

 

There can be no assurance that the reforms to China’s economic systems will continue or that we will not be adversely affected by changes in China’s political, economic, and social conditions and by changes in policies of the Chinese government, such as changes in laws and regulations, measures which may be introduced to control inflation, changes in the rate or method of taxation, imposition of additional restrictions on currency conversion and remittance abroad, and reduction in tariff protection and other import restrictions.

 

EMPLOYEES AND EMPLOYMENT AGREEMENTS

 

The Company currently employs 4,930 employees, all of whom are employed full time and are grouped as follows: 142 for quality control and quality check, 370 technical staffs, 175 sales and marketing staffs, 4,158 production workers and 85 administrative staffs. There are employment agreements with all of the employees. We believe that the employment contracts with all our employees comply with relevant laws and regulations of China. We are not subject to any collective bargaining agreement.

 

The Joint Venture is subject to labor regulations applicable to Sino-Foreign equity joint venture enterprises. Only in compliance with those regulations, may the Joint Venture’s management hire and discharge employees and make other determinations with respect to wages, welfare plans, insurance coverages and disciplinary action with respect to its employees. The Joint Venture has, as required by law, established special funds for enterprise development, employee welfare and incentives, as well as a general reserve. In addition, the Joint Venture is required to provide its employees with facilities sufficient to enable the employees to carry out union activities.

 

DESCRIPTION OF THE JOINT VENTURE

 

General

 

The Joint Venture was established on January 17, 2004, pursuant to the terms of the Joint Venture Agreement with the Ruili Group. Below is a description of the material terms of the Joint Venture.

 

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Management of the Joint Venture

 

Pursuant to the terms of the Joint Venture Agreement, the board of directors of the Joint Venture consists of three directors. We have the right to designate two members of the board of directors and the Ruili Group has the right to designate one member. We also have the authority to appoint the Chairman of the board of directors. The majority of the board of directors is vested with the authority with respect to operating matters. As a result, we maintain operating control over the Joint Venture. However, at this time, three of the directors of the Joint Venture, Messrs. Xiao Ping Zhang, Xiao Feng Zhang and Ms. Shu Ping Chi, are also directors of us and the founders and executives of the Ruili Group, and therefore there is limited independence between the two entities. The term of the Joint Venture will expire on March 4, 2019, although we anticipate that we will be able to extend such term. Extension of the agreement will be subject to negotiation with the Ruili Group and approval of the Chinese government.

 

Distribution of Profits of the Joint Venture

 

After providing social welfare funds for employees and withholding applicable taxes, the profits, if any, of the Joint Venture are available for distribution to the parties in proportion to their respective capital contributions. Any such distributions must be authorized by the Joint Venture’s board of directors. To date, the Joint Venture has not distributed any profits and does not anticipate of doing so in the foreseeable future.

 

Transfer of Interest in the Joint Venture

 

Any assignment or transfer of an interest in the Joint Venture must be approved by the Chinese government. The Chinese joint venture laws also provide for preemptive rights and any proposed transfer to third parties requires the consent of all parties to the joint venture.

 

Liquidation of the Joint Venture

 

Under the Chinese joint venture laws, the Joint Venture may be liquidated in certain limited circumstances, including the expiration of the term of the Joint Venture (including extensions, if any), the inability for the joint venture to continue operations due to severe losses, force majeure, or the failure of a party to perform its obligations under the Joint Venture Agreement or the Articles of Association in such a manner as to impair the operations of the Joint Venture. The Chinese joint venture laws provide that, upon liquidation, the net asset value (based on the prevailing market value of the assets) of a joint venture shall be distributed to the parties in proportion to their respective registered capital in the joint venture.

 

Resolution of Disputes Related to the Joint Venture

 

In the event of a dispute between the parties, attempts will be made to resolve the dispute through friendly consultation or mediation. In the absence of a friendly resolution, the parties have agreed that the matter will first be referred to the China International Economic and Trade Arbitration Commission in Beijing, China, whose decisions are final and enforceable in Chinese courts.

 

Nationalization of Foreign Investments

 

The Chinese joint venture laws provide that China generally will not nationalize enterprises in which foreign funds have been invested. However, under special circumstances, for example, when public interest requires, enterprises with foreign capital may be legally nationalized and appropriate compensation will be made.

 

Available Information

 

We electronically file our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports with the SEC. Copies of our filings with the SEC may be obtained from the SEC’s website, http://www.sec.gov. Access to these filings is free of charge. In addition, we make such materials that are electronically filed with the SEC, available at www.sorl.cn as soon as reasonably practicable. They are also available in print format to any stockholder upon request.

 

ITEM 1A. RISK FACTORS

 

Our business faces many risks. The risks described below may not be the only risks we face. Additional risks that we do not yet know of, or that we currently think are immaterial, may also materially impair our business operations or financial results. If any of the events or circumstances described in the following risks actually occurs, our business, financial conditions or results of operations could suffer and the trading price of our common stock could decline.

 

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Risks Related to the Company

 

If the current financial crisis and the slowdown of the global economy continues, more countries may resort to protectionist measures which would negatively affect our export sales.

 

As a result of global economic conditions and little or no growth in many countries, there is a risk of increased international trade protectionism. Many countries would set up trade barriers which would negatively affect our export sales, as well as increase litigation risk in the countries to which our products are exported.

 

Our ability to effectively implement our business strategy depends upon, among other factors, the successful recruitment and retention of additional highly skilled and experienced management and other key personnel and we cannot assure that we will be able to hire or retain such employees.

 

We must attract, recruit and retain a sizeable workforce of technically competent employees. Our ability to effectively implement our business strategy will depend upon, among other factors, the successful recruitment and retention of additional highly skilled and experienced management and other key personnel. As the economy in China expands, there is increasing competition for skilled workers in China. We cannot assure that we will be able to find, hire or retain such employees, or even if we are able to do so, that the cost of these employees will not adversely affect our net income.

 

Certain of our officers and directors have responsibilities to other businesses in addition to our Company and as a result, conflicts of interest between us and the other activities of those persons may occur from time to time.

 

Certain persons serving as our officers and directors have existing responsibilities and, in the future, may have additional responsibilities, to provide management and services to other entities in addition to us. In particular, Mr. Xiao Ping Zhang, our Chairman and Chief Executive Officer is an officer and a principal stockholder of the Ruili Group, which is engaged in the development, production and sale of various kinds of automotive parts as well as operating a hotel property and investing in the development of real property in China. The management of our Joint Venture is shared with the Ruili Group and therefore there may exist conflicts of interest between us and the Ruili Group in connection with its operation. Our Joint Venture Agreement provides that the board of directors of the Joint Venture is comprised of three persons, two of whom are appointed by us and the remaining one is appointed by the Ruili Group. However, at this time, three of the directors of the Joint Venture, Messrs. Xiao Ping Zhang, Xiao Feng Zhang and Ms. Shu Ping Chi, are also directors of us and the founders and executives of Ruili Group. There can be no assurance that in the event of a conflict between us and the Ruili Group, our interests in the Joint Venture will not be adversely affected or that our Company’s interests will always be fairly represented. The Ruili Group also provides certain services to the Company in the form of bank guaranties and licensing of certain intellectual property rights and technology. As a result, conflicts of interest between us and the Ruili Group may occur from time to time. Our officers and directors are accountable to us and our shareholders as fiduciaries, which requires that such officers and directors exercise the duty of loyalty and the duty of care in managing our affairs. However, the existing responsibilities limit the amount of time such officers and directors can spend on our affairs.

 

We are and will continue to be under downward pricing pressures on our products from our customers and competitors which may adversely affect our growth, profit margins and net income.

 

We face continuing downward pricing pressures from our customers and competitors, especially in the sales of replacement parts. To retain our existing customers and attract new ones, we must continue to keep our unit prices low. In view of our need to maintain low prices on our products, our growth, profit margins and net income will suffer if we cannot effectively continue to control our manufacturing and other costs.

 

Our contracts with our customers are generally short-term and do not require the purchase of a minimum amount, which may result in periods of time during which we have limited orders for our products.

 

Our customers generally do not provide us with firm, long-term volume purchase commitments. Although we enter into manufacturing contracts with certain of our customers who have continuing demand for a certain product, these contracts usually do not provide for firm, long-term commitments to purchase products from us. As a result of the absence of long-term contracts, we could have periods during which we have no or only limited orders for our products, but we continue to have to pay the costs to maintain our work force and our manufacturing facilities and to meet other fixed costs, without the benefit of current revenues.

 

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We consistently face short lead times for delivery of products to customers. Failure to meet delivery deadlines in our production agreements could result in the loss of customers and damage to our reputation and goodwill.

 

We enter into production agreements with our customers prior to commencing production, which reduces our risk of cancellations. However, these production agreements typically contain short lead time for delivery of products, leading to production schedules that can strain our resources and reduce our profit margins on the products produced. Although we have increased our manufacturing capacity, we may lack sufficient capacity at any given time to meet all of our customers’ demands if they exceed production capacity levels. We strive for rapid response to customer demands, which can lead to reduced purchasing efficiency and increased material costs. If we are unable to sufficiently meet our customers’ demands, we may lose our customers. Moreover, failure to meet customer demands may impair our reputation and goodwill.

 

Because of the short lead time in our production agreements, we may not be able to accurately or effectively plan our production or supply needs.

 

We make significant decisions, including determining the levels of business that we will seek and accept, production schedules, component procurement commitments, facility requirements, personnel needs, and other resource requirements, based on our production agreements with our customers. Short lead time of our customers’ commitments to their own customers and the possibility of rapid changes in demand for their products reduce our ability to estimate accurately the future requirements of those customers for our products. Because many of our costs and operating expenses are fixed, a reduction in customer demands can harm our sales, margins and operating results. We may also occasionally acquire raw materials without having customer orders based on a customer’s forecast or in anticipation of an order or to secure more favorable pricing, delivery or credit terms in view of the short lead time we often have under our customers’ orders. These purchases can expose us to losses from inventory carrying costs or inventory obsolescence.

 

Our operations depend highly on Mr. Xiao Ping Zhang, our Chairman and Chief Executive Officer, and Ms. Jin Rui Yu, our Chief Operating Officer, and a small number of other executives, and the loss of any such executive could adversely affect our ability to conduct our business.

 

The success of our operations depends greatly on a small number of key managers, particularly, Mr. Xiao Ping Zhang and Ms. Jin Rui Yu. The loss of the service of Mr. Zhang, or any of the other senior executives could adversely affect our ability to conduct our business. Even if we are able to find other managers to replace any of these managers, the search for such managers and the integration of such managers into our business will inevitably occur only over an extended period of time. During that time the lack of senior leadership could adversely affect our sales and manufacturing activities, as well as our research and development efforts.

 

We may not be able to respond effectively to rapid growth in demands for our products, which could adversely affect our customer relations and our growth prospects.

 

If we continue to be successful in obtaining rapid market penetration of our products, we will be required to deliver large volumes of quality products to customers on a timely basis at a reasonable cost to those customers. Meeting such increased demands will require us to expand our manufacturing facilities, to increase our ability to purchase raw materials, to increase the size of our work force, to expand our quality control capabilities and to increase the scale upon which we produce products. Such demands would require more capital and working capital than we currently have available.

 

We may not be able to finance the development of new products, which could negatively impact our competitiveness.

 

Our future operating results will depend to a significant extent on our ability to continue to provide new products that compare favorably on the basis of cost and performance with the products of our competitors. Some of our competitors have design and manufacturing capabilities and technologies to produce products that compete well with our products, particularly in markets outside of China. We are currently conducting research and development activities on a number of new products, requiring a substantial outlay of capital. To remain competitive, we must continue to incur significant costs in product development, equipment, facilities and invest in research and development of new products. These costs may result in greater fixed costs and operating expenses. All of these factors create pressures on our working capital and ability to fund our current and future manufacturing activities and the expansion of our business.

 

We receive a significant portion of our revenues from a small number of customers which may make it difficult to negotiate attractive prices for our products and expose us to risks of substantial losses if we lose one or more major customers.

 

Although no customer individually accounted for more than 10% of our revenues for the year ended December 31, 2017, our three largest customers accounted for approximately 11.8% and 10.6% of our revenues in 2017 and 2016, respectively. Dependence on a few customers could make it difficult to negotiate attractive prices for our products and could expose us to the risk of substantial losses if one or more major customers stop purchasing our products.

 

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Our business depends on our ability to protect and enforce our intellectual property rights effectively which may be difficult particularly in China.

 

The success of our business depends on the legal protection of the intellectual property rights we hold. As of the fiscal year ended December 31, 2017, we own 617 patents and additional 745 under applications. We claim proprietary rights in various unpatented technologies, know-how, trade secrets and trademarks relating to products and manufacturing processes. We protect our proprietary rights in our products and operations through contracts, including nondisclosure agreements. If these contractual measures fail to protect our proprietary rights, any advantage that those proprietary rights provide to us would be negated. Monitoring infringement of intellectual property rights is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our intellectual property and/or know-how, particularly in China and other countries in which the laws may not protect our proprietary rights as fully as the laws of the United States. Accordingly, other parties, including competitors, may improperly duplicate our products using our proprietary technologies. Pursuing legal remedies against persons infringing our patents or otherwise improperly using our proprietary information is a costly and time consuming process that would divert management’s attention and other resources from the conduct of our normal business, and could cause delays and other problems with the marketing and sales of our products, as well as delays in deliveries.

 

It may be difficult to find or integrate acquisition targets which could have an adverse effect on our expansion plans.

 

An important component of our growth strategy is to invest in or acquire companies such as other automotive parts manufacturers and distribution companies. We may be unable to identify suitable investment or acquisition candidates, or to make these investments or acquisitions on a commercially reasonable basis, if at all. If we complete an investment or acquisition, we may not realize the anticipated benefits from the transaction.

 

Integrating an acquired company is a complex, distracting, time consuming and potentially expensive process. The successful integration of an acquisition target would require us to:

 

·integrate and retain key management, sales, research and development, and other personnel;
·incorporate the acquired products or capabilities into ours from engineering, sales and marketing perspectives;
·coordinate research and development efforts;
·integrate and support pre-existing supplier, distribution and customer relationships; and
  · Consolidate duplicate facilities and functions and combine administrative, accounting and order processing and supporting functions.

 

The geographic distance between the companies, the complexity of the technologies and operations being integrated and the disparate corporate cultures being combined may increase the difficulties of combining an acquired company. Acquired businesses are likely to have different standards, controls, contracts, procedures and policies, making it more difficult to implement and harmonize company-wide financial, accounting, billing, information and other systems. Management’s focus on integrating operations may distract attention from our day-to-day business and may disrupt key research and development, marketing or sales efforts.

 

With the automobile parts markets being highly competitive and many of our competitors having greater resources than we do, we may not be able to compete successfully.

 

The automobile parts industry is highly competitive. Factors considered by our customers and potential customers include:

 

·Quality;
·Price/cost competitiveness;
·Product performance;
·Reliability and timeliness of delivery;
·New product and technology development capability;
·Degree of global and local presence;
·Effectiveness of customer service; and
·Overall management capability.

 

Depending on the particular product market (Chinese OEM Market or Chinese Aftermarket) and geographic market, the number of our competitors varies significantly. Many of our competitors have substantially greater revenues and financial resources than we do, as well as stronger brand names, higher consumer recognition, better business relationships with vehicle manufacturers, and broader geographic presence than we have, especially where we intend to enter a new geographic market. We may not be able to compete effectively and increased competition may substantially harm our market position.

 

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Internationally, we face different market dynamics and competition. We may not be as successful as our competitors in generating revenues in international markets due to the lack of recognition of our brands, products or other factors. Developing product recognition overseas is expensive and time-consuming and our international expansion efforts may be more costly and less profitable than we expect.

 

If we are not able to expand our business in our target markets, our sales could decline, our margins could be negatively impacted and we could lose market share.

 

A disruption at our sole manufacturing site would significantly interrupt our production capabilities, which could have drastic consequences to us, including threatening our financial viability.

 

We currently manufacture all of our products at our sole commercial manufacturing facility, which is located near Ruian City, Wenzhou, Zhejiang Province, China. Accordingly, we face risks inherent in operating a single manufacturing facility, since any disruption, such as a fire, or natural disaster, could significantly interrupt our manufacturing capability. We currently do not have alternative production plans in place or disaster-recovery facilities available. In case of a disruption, we will have to lease, acquire or build alternative manufacturing facilities. This would require substantial capital on our part, which we may not be able to obtain on commercially acceptable terms or at all. Additionally, we would likely experience months or years of production delays as we build or look for replacement facilities and seek necessary regulatory approvals. If this occurs, we will be unable to satisfy customer orders on a timely basis, if at all. Also, operating any new facilities may be more expensive than operating our current facility. For these reasons, a significant disruptive event at our manufacturing facility could have drastic consequences on us, including threatening our financial viability.

 

The cyclical nature of commercial vehicle production and sales could result in a reduction in automotive sales, which could adversely affect our financial liquidity.

 

Our sales to OEMs depend on automotive commercial vehicle production and sales by our customers, which are highly cyclical and affected by general economic conditions and other factors, including consumer spending and preferences. They also can be affected by government policies, labor relations issues, regulatory requirements, and other factors. In addition, in the last two years, the price of commercial vehicles in China has generally declined. As a result, the volume of commercial vehicle productions in China has fluctuated from year to year, which has caused fluctuations in the demand for our products.

 

Increasing costs for manufactured components and raw materials may adversely affect our profitability.

 

We use a broad range of manufactured components and raw materials in our products, including castings, electronic components, finished sub-components, molded plastic parts, fabricated metal, aluminum and steel, and resins. Because it may be difficult to pass price increases for these items on to our customers, a significant increase in the prices of our components and materials could materially increase our operating costs and adversely affect our profit margins and profitability.

 

Longer product life of parts may reduce aftermarket demand for some of our products.

 

In 2017, approximately 35.4% of our sales were sales to the aftermarket. The average useful life of original equipment parts has been steadily increasing in recent years due to improved quality and innovations in products and technologies. Longer product lives allow vehicle owners to replace parts of their vehicles less often. Additional increases in the average useful life of automotive parts are likely to adversely affect the demand for our aftermarket products.

 

We may be subject to product liability, warranty and recall claims, which may increase the costs of doing business and adversely affect our financial condition and liquidity.

 

We face an inherent business risk of exposure to product liability and warranty claims if our products actually or allegedly fail to perform as expected or the use of our products results, or is alleged to result, in bodily injury and/or property damage. We have not obtained product liability insurance and therefore may be exposed to potential liability without any insurance. We cannot assure you that we would not incur significant costs to defend any claims or that we will not experience any product liability losses in the future. In addition, if any of our designed products are or are alleged to be defective, we may be required to participate in a recall of such products. We cannot assure you that the future costs associated with providing product warranties and/or bearing the cost of repair or replacement of our products will not have an adverse effect on our financial condition and liquidity.

 

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We are subject to environmental and safety regulations, which may increase our compliance costs.

 

We are subject to the requirements of environmental and occupational safety and health laws and regulations in China and other countries where we sell our products. To the extent that we expect to expand our operations into other geographic areas, we will become subject to such laws and regulations of those countries as well. We cannot provide assurance that we have been or will be at all times in full compliance with all of these requirements, or that we will not incur material costs or liabilities in connection with these requirements. The capital requirements and other expenditures that may be necessary to comply with environmental and safety requirements could increase and become a material expense of doing business.

 

Non-performance by our suppliers may adversely affect our operations by delaying delivery or causing delivery failures, which may negatively affect customer demands, sales and profitability.

 

We purchase various types of equipment, raw materials and manufactured component parts from our suppliers. We would be materially and adversely affected by the failure of our suppliers to perform as expected. We could experience delivery delays or failures caused by production issues or delivery of non-conforming products if our suppliers failed to perform, and we also face these risks in the event any of our suppliers becomes insolvent or bankrupt.

 

Our commercial viability depends significantly on our ability to operate without infringing the patents and other proprietary rights of third parties.

 

In the event that our technologies infringe or violate the patent or other proprietary rights of third parties, we may be prevented from pursuing product development, manufacturing or commercialization of our products that utilize such technologies. We may not be aware that our products or operations infringe upon patents or other rights held by others. In addition, given the complexities and uncertainties of patent laws, there may be patents that we currently do not believe we fringe but in the future we may ultimately be held to infringe, particularly if the claims of such patents are determined to be broader than we believe them to be. As a result, avoiding patent infringement may be difficult.

 

If a third party claims that we infringe its patents, any of the following may occur:

 

·We may become liable for substantial damages for past infringement if a court decides that our technologies infringe upon a competitor’s patent;
·A court may prohibit us from selling or licensing our product without a license from the patent holder, which may not be available on commercially acceptable terms or at all, or which may require us to pay substantial royalties or grant cross-licenses to our patents; and
·We may have to redesign our product so that it does not infringe upon others’ patent rights, which may not be possible or could require substantial funds or time.

 

In addition, employees, consultants, contractors and others may use trade secrets of others in their work for us or disclose our trade secrets to others. Any of such conducts could lead to disputes over the ownership of inventions derived from that information or expose us to potential damages or other penalties. If any of these events occurs, our business will likely suffer and the market price of our common stock will likely decline.

 

Our international expansion plans subject us to risks inherent in doing business internationally.

 

Our long-term business strategy relies on the expansion of our international sales outside China by targeting markets, such as Europe and the United States. Risks affecting our international expansion include challenges caused by distance, language and cultural differences, conflicting and changing laws and regulations, international import and export legislation, trading and investment policies, foreign currency fluctuations, the burdens of complying with a wide variety of laws and regulations, protectionist laws and business practices that favor local businesses in some countries, foreign tax consequences, higher costs associated with doing business internationally, restrictions on the export or import of technology, difficulties in staffing and managing international operations, trade and tariff restrictions, and variations in tariffs, quotas, taxes and other market barriers. These risks could harm our international expansion efforts, which could in turn materially and adversely affect our business, operating results and financial condition.

 

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Risks Related to Doing Business in China or Owning Shares in China-Based Business

 

We operate from facilities that are located in China. Our principal operating subsidiary, Ruili Group Ruian Auto Parts Co., Ltd., is a Sino-Foreign joint venture organized under the laws of China.

 

Changes in China’s political and economic policies and conditions could cause a substantial decline in the demand for our products and services.

 

Historically, we have derived a substantial portion of our revenues from China. We anticipate that China will continue to be our primary production location and an important sales base in the near future. Currently, almost all of our production assets are located in China. While the PRC government has pursued economic reforms to transform its economy from a planned economy to a market-oriented economy since 1979, a large part of the PRC economy is still being operated under varying degrees of control by the PRC government. By imposing industrial policies and other economic measures, such as restrictions on lending to certain sectors of the economy, control of foreign exchange, taxation and restrictions on foreign participation in the domestic market of various industries, the PRC government exerts considerable direct and indirect influence on the PRC economy. Many of the economic reforms carried out by the PRC government are unprecedented or experimental and are subject to risks and even set-backs. Other political, economic and social factors may also lead to further adjustments of the PRC reform measures. This refining and adjustment process may have a negative effect on our operations and our future business development. For example, the PRC government has in the past implemented a number of measures intended to slow down certain segments of the PRC economy that the PRC government believed to be overheating, including placing additional limitations on the ability of commercial banks to make loans by raising bank reserve-against-deposit ratios. Historically, this restrictive policy on loans had the effect of decreasing infrastructure projects resulting in a decrease in demand for heavy trucks, thus adversely impacting our product sales to our OEM customers. Because of the negative impact of the Chinese government policies on the truck manufacturers, we also were required to extend our normal credit terms to certain of these manufacturers. Our operating results may be materially and adversely affected by changes in the PRC economic and social conditions and by changes in the policies of the PRC government, such as measures to control inflation, changes in the rates or method of taxation and the imposition of additional restrictions on currency conversion.

 

Changes in foreign exchange regulations in China may affect our ability to pay dividends in foreign currencies.

 

The official currency of the PRC, Renminbi (RMB), is not a freely convertible currency and the restrictions on currency exchanges in China may limit our ability to use revenues generated in RMB to fund our business activities outside China or to make dividends or other payments in U.S. dollars. The PRC government strictly regulates conversion of RMB into foreign currencies. Over the years, the PRC government has significantly reduced its control over routine foreign exchange transactions under current accounts, including trade-and service-related foreign exchange transactions, foreign debt service and payment of dividends. In accordance with the existing foreign exchange regulations in China, our PRC joint venture may pay dividends in foreign currencies, without pre-approval from the PRC State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. The PRC government may, however, at its discretion, restrict access in the future to foreign currencies for current account transactions and prohibit us from converting our RMB-denominated earnings into foreign currencies. If this occurs, our PRC joint venture may not be able to pay us dividends in foreign currency without prior approval from SAFE. Foreign exchange transactions under the capital account remain subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities. This could affect our ability to obtain foreign currency through debt or equity financing and our ability to make overseas acquisitions or investments.

 

Fluctuation in the value of RMB could adversely affect the value of, and dividends payable on, our shares in foreign currency terms.

 

The value of RMB is subject to changes in PRC government policies and depends to a large extent on China’s domestic and international economic, financial and political developments, as well as the currency’s supply and demand in the local market. For over a decade from 1994, the conversion of RMB into foreign currencies, including the U.S. dollar, was based on exchange rates set and published daily by the People’s Bank of China, the PRC central bank, based on the previous day’s interbank foreign exchange market rates in China and exchange rates on the world financial markets. The official exchange rate for the conversion of RMB into U.S. dollars remained stable until RMB was revalued in July 2005 and allowed to fluctuate by reference to a basket of foreign currencies, including the U.S. dollar. Under the new policy, RMB will be permitted to fluctuate within a band against a basket of foreign currencies. There remains significant international pressure on the PRC government to adopt a substantially more liberalized currency policy, which could result in a more volatile fluctuation in the value of RMB against the U.S. dollar, which may materially and negatively impact our costs of doing business and revenues from export sales.

 

 20 

 

 

The uncertain legal environment in China could limit the legal protections available to our shareholders.

 

The PRC legal system is a civil law system based on written statutes. Unlike the common-law system, the civil law system is a system in which decided legal cases have little precedential value. In the late 1970s, the PRC government began to promulgate a comprehensive system of laws and regulations to provide general guidance on economic and business practices in China and to regulate foreign investments. Our PRC joint venture is a Sino-Foreign joint venture and is subject to laws and regulations applicable to foreign investment in China in general and laws and regulations applicable to foreign-invested enterprises in particular. China has made significant progress in the promulgation of laws and regulations dealing with economic matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, the promulgation of new laws, changes of existing laws and abrogation of local regulations by national laws may have a negative impact on our business and prospects. In addition, as these laws, regulations and legal requirements are relatively recent and because of the limited volume of published cases, the interpretation and enforcement of those laws, regulations and legal requirements involve significant uncertainties. These uncertainties could limit the legal protections available to foreign investors, including our shareholders. For example, it is not clear if a PRC court would enforce in China a foreign court decision made in any case brought by our shareholders against us in shareholders’ derivative actions.

 

Moreover, the enforceability of contracts in China, especially with governmental entities, including state-owned enterprises, is relatively uncertain. If counterparties repudiated our contracts or defaulted on their obligations, we might not have adequate remedies. Such uncertainties or inability to enforce our contracts could materially and adversely affect our revenues and earnings.

 

Our primary source of funds for dividends and other distributions from our operating subsidiary in China is subject to various legal and contractual restrictions and uncertainties as well as the practice of such subsidiary in declaring dividends, and our ability to pay dividends or make other distributions to our shareholders may be negatively affected by those restrictions, uncertainties and dividend practices.

 

We conduct our core business operations through the Joint Venture. As a result, our profits available for distribution to our shareholders are dependent on the profits available for distribution from the Joint Venture. Under current PRC law, the Joint Venture is regarded as a foreign-invested enterprise in China. Although dividends paid by foreign invested enterprises are not subject to any PRC corporate withholding tax, PRC law permits payment of dividends only out of net income as determined in accordance with PRC accounting standards and regulations. Determination of net income under PRC accounting standards and regulations may differ from determination under U.S. GAAP in significant aspects, such as the use of different principles for recognition of revenues and expenses. Under PRC law, the Joint Venture is required to set aside 10% of its net income each year to fund a designated statutory reserve fund until such funds reach 50% of registered share capital. These reserves are not distributable as cash dividends. As a result, our primary internal source of funds for dividend payments is subject to these and other legal and contractual restrictions and uncertainties, which in turn may limit or impair our ability to pay dividends to our shareholders although we do not presently anticipate paying any dividends. Moreover, any transfer of funds from us to the Joint Venture, either as a shareholder loan or as an increase in registered capital, is subject to registration with or approval by PRC governmental authorities. These limitations on the flow of funds between us and the Joint Venture could restrict our ability to act in response to changing market conditions. To date, the Joint Venture has not distributed any profits and does not anticipate doing so in the foreseeable future.

 

China’s economic reform policies, including the risk of nationalization, could result in a total investment loss in our common stock.

 

Since 1979, the Chinese government has reformed its economic systems. Because many reforms are unprecedented or experimental, they are subject to risks and even set-backs. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or the disparities in per capita wealth between regions within China, could lead to further adjustment of the reform measures. This refining and adjustment process may negatively affect our operations.

 

Although the Chinese government controls many productive assets in China, in the past several years the government has implemented economic reform measures that emphasize decentralization and encourage private economic activities. Because these economic reform measures may be inconsistent or ineffectual, there are no assurances that:

 

·We will be able to capitalize on economic reforms;
·The Chinese government will continue its pursuit of economic reform policies;
·The economic policies, even if pursued, will be successful;
·Economic policies will not be significantly altered from time to time; and
·Business operations in China will not become subject to the risk of nationalization.

 

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There can be no assurance that the reforms to China’s economic system will continue or that we will not be adversely affected by changes in China’s political, economic, and social conditions and by changes in policies of the Chinese government, such as changes in laws and regulations, measures which may be introduced to control inflation, changes in the rate or method of taxation, changes affecting currency conversion and remittance abroad, and changes in tariffs and other import controls. A material change in China’s economic reform policies, including the risk of nationalization, could result in a total loss of investment in our common stock.

 

Because our principal operating company is organized under the laws of China, and substantially all of our assets are located in China, our shareholders may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China against us or our management.

 

The Joint Venture is incorporated under the laws of China and substantially all of our assets are located in China. In addition, all of our directors and executive officers reside within China, and substantially all of the assets of these persons are located within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon our directors or executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state laws. Moreover, China does not have treaties providing for the reciprocal recognition and enforcement of court judgments with the United States, the United Kingdom, Japan or many other countries. As a result, recognition and enforcement in China of judgments issued by courts in the United States or any of the other jurisdictions mentioned above in relation to any matter may be difficult or impossible. Furthermore, an original action may be brought in China against us, our directors, managers, or executive officers. In connection with any such original action, a Chinese court may award civil liability, including monetary damages. However, there is no assurance that such judgment can be effectively or timely enforced in China.

 

It is likely that China will adopt stricter environmental regulations relating to the manufacturing, transportation, storage, use and disposal of materials used to manufacture our products or restricting the disposal of any waste by us, which would likely increase our operating costs.

 

National, provincial and local laws of China impose various environmental regulations relating to the manufacturing of automotive parts and/or of certain materials used in the manufacturing process of automotive parts. Although we believe that our operations are in substantial compliance with current environmental regulations, there can be no assurance that changes in such laws and regulations will not impose costly compliance requirements on us or otherwise subject us to future liabilities. In addition, China is experiencing substantial problems with environmental pollution. Accordingly, it is likely that its national, provincial and local governmental agencies will adopt stricter pollution controls. Any such regulations relating to the manufacturing, transportation, storage, use and disposal of materials used to manufacture our products or restricting the disposal of any waste by us would likely increase our operating costs.

 

Risks Related to Our Common Stock

 

The market price for our common stock may be volatile, which could result in a complete loss of your investment.

 

The market price for our common stock may be volatile, in response to factors, such as:

 

·actual or anticipated fluctuations in our quarterly operating results;
·announcements of new products by us or our competitors;
·changes in financial forecasts by securities analysts;
·changes in the economic performance or market valuations of other companies involved in the production of automotive parts;
·announcements by our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
·additions or departures of key personnel;
·intellectual property or other litigation; and
·changes in conditions in the automotive market, including change in macroeconomic conditions or other development in the market, especially in China.

 

In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock.

 

 22 

 

 

We may issue additional shares of our capital stock to raise additional cash to fund working capital. If we issue additional shares of our capital stock, our stockholders may experience dilution in their respective percentage ownership in us.

 

We may seek to further expand our operations and therefore we may issue additional shares of our capital stock to raise additional cash to fund working capital. If we issue additional shares of our capital stock, our stockholders may experience dilution in their respective percentage ownership in us.

 

A large portion of our common stock is controlled by a small number of stockholders and as a result, these stockholders collectively are able to control the outcome of stockholder votes on various matters.

 

A large portion of our common stock is held by a small number of stockholders. Mr. Xiao Ping Zhang, our Chairman and Chief Executive Officer, his wife Ms. Shu Ping Chi, and his brother Mr. Xiao Feng Zhang, all of whom are the directors of our board, holding approximately 47.1%, 5.9% and 5.9% respectively, of the Company’s outstanding common stock as of December 31, 2017. As a result, these stockholders collectively are able to control the outcome of stockholder votes on various matters, including the election of directors and other corporate transactions including business combinations.

 

Because of the relatively small public float of our common stock, any sale of a large number of shares of our common stock, or the market perception that such a sale could occur, may significantly affect our stock price and could impair our ability to raise future capital.

 

Because of the relatively small public float of our common stock, any sale of a large number of shares of our common stock, or the perception that such sale could occur, may significantly affect our stock price and could impair our ability to raise future capital through an offering of equity securities. This could have an adverse effect on our business by restricting our access to working capital to fund growth and operations.

 

If we cannot continue to satisfy the Nasdaq Global Market’s listing maintenance requirements and other Nasdaq rules, our common stock could be delisted, which could negatively affect the price of our common stock and your ability to sell them.

 

In order to maintain our listing on the Nasdaq Global Market, we will be required to comply with Nasdaq rules which include rules regarding minimum shareholders’ equity, minimum share price, and certain corporate governance requirements. We may not be able to continue to satisfy the listing maintenance requirements of the Nasdaq Global Market and other applicable Nasdaq rules. If we are unable to satisfy the NASDAQ criteria for maintaining listing, our common stock could be subject to delisting. If our common stock is delisted, trading, if any, of our common stock would thereafter be conducted in the over-the-counter market, such as the so-called “OTC Pink” or the Over-the-Counter Bulletin Board (“OTCBB”). As a consequence of any such delisting, our share price could be negatively affected and our stockholders would likely find it more difficult to dispose of, or to obtain accurate quotations as to the prices of, our common stock.

 

We do not intend to pay dividends on shares of our common stock in the foreseeable future.

 

We have never paid cash dividends on our common stock. Our current board of directors does not anticipate that we will pay cash dividends in the foreseeable future. Instead, we intend to retain future earnings for reinvestment in our business and/or to fund future acquisitions. Determination of net income under PRC accounting standards and regulations may differ from determination under U.S. GAAP in significant aspects, such as the use of different principles for recognition of revenues and expenses. Under PRC law, the Joint Venture is required to set aside a portion of its net income each year to fund designated statutory reserve funds.

 

We may be required to indemnify our officers and directors, which could result in substantial expenditures, which we may be unable to recoup.

 

Our Bylaws provide for the indemnification of our directors, officers, employees, and agents, under certain circumstances, for damages, attorneys’ fees and other expenses incurred by them in any litigation to which they become a party arising from their association with or activities on behalf of us. Such indemnification obligations could result in substantial expenditures, which we may be unable to recoup.

 

 23 

 

 

There can be no assurance that we will have the personnel, financial resources or expertise to continue to meet requirements of Sarbanes-Oxley Act.

 

The US Public Company Accounting Reform and Investor Protection Act of 2002, better known as the Sarbanes-Oxley Act, was one of the most sweeping laws to affect U.S. publicly-traded companies in 70 years. The Sarbanes-Oxley Act created a set of complex and burdensome regulations. Compliance with such regulations imposes substantial burdens in terms of financial expense and commitment of personnel. There can be no assurance that we will have the personnel, financial resources or expertise to continue to meet requirements of these regulations.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

Our facilities are located in Ruian City, Wenzhou Area, Zhejiang Province, People’s Republic of China, which boasts many automotive parts production facilities similar to ours. On May 5, 2016, through its principal operating subsidiary, the Company entered into a Purchase Agreement (the “Purchase Agreement”) with the Ruili Group, 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 agree to transfer to the Ruili Group the land use rights and factory facilities of the Dongshan Facility, plus RMB501,000,000 (approximately $76,533,000) in cash.

 

The cash consideration in the amount of RMB481,000,000 (approximately $73,478,000) was paid to the Ruili Group in installments before June 30, 2016, and the remaining RMB20,000,000 (approximately $3,016,000) 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. As of the filing date, the Company has not obtained the land use right certificate nor the property ownership certificate of the Development Zone Facility. The total floor area of the Dongshan Facility is 58,714 square meters, which the Company purchased from the Ruili Group in 2007. The total floor area of the Development Zone Facility is 157,619 square meters, which will provide more manufacturing and service capacity to support the Company’s future growth. At the time of the purchase, the Company was leasing 89,229 square meters of the Development Zone Facility from Ruili Group for its brake systems business, of which the lease was going to expire on December 31, 2017. This lease was terminated upon the completion of the purchase. The purchase of the Development Zone Facility would allow the Company to acquire full ownership and control over these important production facilities. The transaction was approved by a committee of independent directors of the Company based on the valuation reports of the Development Zone Facility and the Dongshan Facility provided by an independent real estate appraisal firm.

 

At the production facility, the Company has production equipment, imported from the United States, Korea, and Taiwan, as well as manufactured in mainland China.

 

ITEM 3. LEGAL PROCEEDINGS

 

Neither our company nor any of our subsidiaries is a party to any legal proceedings that, individually or in the aggregate, are material to our financial statements, as a whole.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTER AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

Price Range of Common Stock

 

On April 18, 2006, our shares of common stock began trading on the Nasdaq Capital Market under the symbol “SORL”. Subsequently, our shares of common stock began trading on the Nasdaq Global Market on November 21, 2006 under the symbol “SORL”. High and low sales prices per share of our common stock as reported on Nasdaq for each quarter ended during 2017 and 2016 are as follows:

 

Quarter Ended  Low   High 
         
2017          
First Quarter  $2.68   $4.25 
Second Quarter   3.59    9.74 
Third Quarter   3.70    8.70 
Fourth Quarter   3.75    8.45 
           
2016          
First Quarter  $1.39   $2.57 
Second Quarter   1.50    1.99 
Third Quarter   1.68    4.85 
Fourth Quarter   2.76    5.05 

 

These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions. The high and low prices listed have been rounded up to the next highest two decimal places.

 

Stockholders

 

At March 31, 2018, we had approximately 681 registered stockholders of record of our common stock. This number does not include shares beneficially owned by investors through brokerage clearing houses, depositories or otherwise held in “street name.”

 

Dividends

 

We have not declared or paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. Payment of cash dividends, if any, in the future will be at the sole discretion of our board of directors and will depend upon our debt and equity structure, earnings and financial condition, need for capital in connection with possible future acquisitions and other factors including economic conditions, regulatory restrictions and tax considerations. Additionally, amounts available for dividends are dependent on the profits available for distribution from the Joint Venture. Under current PRC law, the Joint Venture is regarded as a foreign invested enterprise in China. Although dividends paid by foreign invested enterprises are not subject to any PRC corporate withholding tax, PRC law permits payment of dividends only out of net income as determined in accordance with PRC accounting standards and regulations. Determination of net income under PRC accounting standards and regulations may differ from determination under U.S. GAAP in significant aspects, such as the use of different principles for recognition of revenues and expenses. Under PRC law, the Joint Venture is required to set aside a portion of its net income each year to fund designated statutory reserve funds. These reserves are not distributable as cash dividends. Such restrictions and requirements have materially limited or impaired our ability to pay dividends to our shareholders although we do not presently plan to declare or pay any dividends on our common stock. Moreover, any transfer of funds from us to the Joint Venture, either as a shareholder loan or as an increase in registered capital, is subject to registration with or approval by PRC governmental authorities. These limitations on the flow of funds between us and the Joint Venture could restrict our ability to act in response to changing market conditions.

 

ITEM 6. SELECTED FINANCIAL DATA.

 

Not applicable.

 

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ITEM 7. 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 financial statements, as well as information relating to the plans of our current management. This report includes forward-looking statements. Generally, the words “believes,” “anticipates,” “may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar expressions or the negative thereof or comparable terminology are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including the matters set forth in this report and other reports or documents we file with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those presented. Undue reliance should not be placed on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update these forward-looking statements.

 

The following discussion and analysis of our financial condition and results should be read in conjunction with our consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Annual Report on Form 10K.

 

OVERVIEW

 

On May 10, 2004, we acquired all of the issued and outstanding equity interests of Fairford Holdings Limited, a Hong Kong limited liability company (“Fairford”). Until we acquired Fairford, we had only nominal assets and liabilities and limited business operations. Although Fairford became our wholly-owned subsidiary following the acquisition, because the acquisition resulted in a change of control, the acquisition was recorded as a “reverse merger” whereby Fairford was considered to be the accounting acquirer. As such, the following results of operations were those of Fairford.

 

Fairford was organized in Hong Kong as a limited liability company on November 3, 2003. Fairford owns 90% of the equity interest of Ruili Group Ruian Auto Parts Co., Ltd., a Sino-Foreign joint venture (the “Joint Venture”) established pursuant to the laws of China. The Joint Venture is a joint venture between our wholly-owned subsidiary Fairford, and the Ruili Group.

 

The Ruili Group was incorporated in the PRC in 1987 to specialize in the development, production and sale of various kinds of automotive parts. Its headquarters are located in Ruian City, Wenzhou Area, Zhejiang Province, People’s Republic of China, one of the leading automotive parts manufacturing centers of China with more than 1400 auto parts manufacturing companies. Its major product lines include valves for air brake systems, auto metering products, auto electric products, anti-lock brake systems and retarders. Some of those products were developed and are manufactured through affiliated companies of Ruili Group. Due to its leading position in the industry, the Chairman of the Ruili Group, Mr. Xiao Ping Zhang, has been elected as the Chairman of Wenzhou Auto Parts Association, one of the leading auto parts trade associations in China. Mr. Zhang is also the Chairman and Chief Executive Officer of the Company. The Joint Venture was established in the PRC as a Sino-Foreign joint venture company with limited liability by the Ruili Group and Fairford. Fairford and Ruili Group contributed 90% and 10%, respectively, of the paid-in capital of the Joint Venture in the aggregate amount of approximately $53.8 million.

 

In connection with its formation, effective January 19, 2004, the Joint Venture acquired the business of the Ruili Group relating to the manufacture and sale of various kinds of valves for automotive brake systems and related operations (the “Transferred Business”). This was accomplished by the transfer from the Ruili Group to Fairford of the relevant assets and liabilities of the Transferred Business including trade receivables, inventories and machinery, and the assumption of short and long term borrowings, at a consideration of approximately $6.39 million.

 

The consideration was based on a valuation by an independent PRC valuation firm. Fairford then contributed these assets and liabilities as capital contribution for its 90% interest in the Joint Venture. The Ruili Group also transferred inventory as its capital contribution for its 10% interest in the Joint Venture. The assets and liabilities transferred to the Joint Venture by Fairford and the Ruili Group represented all the relevant assets and liabilities of the Transferred Business.

 

Pursuant to the formation of the Joint Venture, on January 17, 2004, the Ruili Group and Fairford signed a binding Joint Venture agreement (the “JV Agreement”). Pursuant to the JV Agreement, the board of directors consists of three directors. Fairford has the right to designate two members of the board and the Ruili Group has the right to designate one member. The majority of the board has decision making authority with respect to operating matters. As a result, our wholly-owned subsidiary, Fairford, maintains operating control over the Joint Venture.

 

The transactions were accounted for as a reverse spin-off in accordance with EITF 02-11 “Accounting for Spin-offs”. Accordingly SORL Auto Parts, Inc. was deemed to be the “spinner” for accounting purposes.

 

 26 

 

 

In December 2006, pursuant to the terms of the Joint Venture Agreement, as revised, through Fairford, SORL invested a further approximately $32.67 million in its operating subsidiary- the Joint Venture. To maintain its 10% shareholding in the Joint Venture, the Ruili Group increased its capital investment by approximately $3.63 million. SORL Auto Parts, Inc. continues to hold a 90% controlling interest in the operating subsidiary. Pursuant to the JV Agreement and the Joint Venture Agreement, as revised, the total paid-in capital of the Joint Venture increased from $7.1 million to $43.4 million.

 

As a result of the foregoing, through Fairford’s 90% interest in the Joint Venture, the Company manufactures and distributes automotive brake systems and other key safety related components in China and internationally for use primarily in different types of vehicles, such as trucks and buses. There are 65 categories of valves with over 2,000 different specifications. Management believes that it is the largest manufacturer of automotive air brake systems for commercial vehicles in China.

 

On November 11, 2009, the Company, through its wholly owned subsidiary, Fairford, entered into a joint venture agreement with MGR, a Hong Kong-based global auto parts distribution specialty firm and an unaffiliated Taiwanese individual investor. The new joint venture was named SORL International Holding, Ltd. ("SIH") based in Hong Kong. Fairford holds a 60% interest in SIH, MGR holds a 30% interest, and the Taiwanese individual investor holds a 10% interest. SIH is primarily devoted to expand SORL's international sales network in the Asia-Pacific region and create 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 individual investor for US$77 (HK$600), and the share transfer was approved by the Hong Kong authorities on January 14, 2016. After this transaction, SIH ceased to be a distributor of SORL in the international market.

 

On February 8, 2010, the Company sold 1,000,000 shares of its common stock to selected institutional investors at a price of $10.00 per share pursuant to a registered direct offering. This transaction provided net proceeds of approximately $9.4 million. On March 9, 2010, through Fairford, SORL invested $9.4 million in its operating subsidiary, the Joint Venture. To maintain its 10% shareholding in the Joint Venture, the Ruili Group increased its capital investment by $1.0 million. Accordingly, SORL continues to hold a 90% controlling interest in the operating subsidiary. The total paid-in capital of the Joint Venture increased from $43.4 million to $53.8 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 (the "Seller", a related party under common control). As a result of this acquisition, the Company's product offerings expanded to both commercial and passenger vehicles' brake systems and other key safety-related auto parts. The purchase price was RMB 170 million, or approximately US$25 million. The transaction was accounted for using the book value of assets acquired, consisting primarily of machinery and equipment, inventory, accounts receivable and patent rights, used or usable in connection with the acquired segment of the auto parts business of the Seller. The Company purchased the machinery and equipment, inventory, accounts receivable at book values of approximately US$8.0 million, US$8.0 million and US$5.2 million, respectively. The Company did not acquire any of the assets of the Seller other than those in the segment of Seller's business described above. The excess of consideration over the carrying value of net assets received has been recorded as a decrease in the additional paid-in capital of the Company.

 

The Company accounted for the acquisition as a transaction between the entities under common control because Mr. Xiao Ping Zhang, the Chairman and CEO of the Company, owns 63% of the registered capital of the Ruili Group, and, together with his wife (Ms. Shu Ping Chi) and brother (Mr. Xiao Feng Zhang), owns approximately 58.8% 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.

 

On October 30, 2015, Mr. Xiao Ping Zhang, the Chairman and CEO of the Company, together with his wife (Ms. Shu Ping Chi) and brother (Mr. Xiao Feng Zhang) (collectively, the “Consortium”) submitted a non-binding proposal (the “Proposal”) to the board of directors of the Company proposing to acquire all of the outstanding shares of the Company’s common stock not already owned by the Consortium at a price of $2.84 per share in cash and if successful in that acquisition, to cause the Company’s common stock to be delisted from NASDAQ and to be deregistered under the Securities Exchange Act of 1934, as amended. The board of directors subsequently formed a special committee (the “Special Committee”) consisting of independent directors to evaluate the Proposal. On January 8, 2016, the Consortium sent a letter to the Special Committee withdrawing the Proposal citing concerns over recent market conditions.

 

On May 5, 2016, the Company, through its principal operating subsidiary, entered into a Purchase Agreement (the “Purchase Agreement”) with the Ruili Group, 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 agree to transfer to the Ruili Group the land use rights and factory facilities of the Dongshan Facility, plus RMB501,000,000 (approximately $76,533,000) in cash.

 

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The cash consideration in the amount of RMB481,000,000 (approximately $73,478,000) was paid to the Ruili Group in installments before June 30, 2016, and the remaining RMB20,000,000 (approximately $3,016,000) 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. As of the filing date, the Company has not obtained the land use right certificate nor the property ownership certificate of the Development Zone Facility. The total floor area of the Dongshan Facility is 58,714 square meters, which the Company purchased from the Ruili Group in 2007. The total floor area of the Development Zone Facility is 157,619 square meters, which will provide more manufacturing and service capacity to support the Company’s future growth. At the time of the purchase, the Company was leasing 89,229 square meters of the Development Zone Facility from Ruili Group for its brake systems business, of which the lease was going to expire on December 31, 2017. This lease was terminated upon the completion of the purchase. The purchase of the Development Zone Facility would allow the Company to acquire full ownership and control over these important production facilities. The transaction was approved by a committee of independent directors of the Company based on the valuation reports of the Development Zone Facility and the Dongshan Facility provided by an independent real estate appraisal firm.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires us to make judgments and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Those judgments and estimates have a significant effect on the consolidated financial statements because they result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Actual results could differ significantly from those estimates. We periodically re-evaluate our judgments and estimates that are based upon historical experience and on various other assumptions that we believe to be reasonable under the circumstances.

 

We believe that the following critical accounting policies set forth below involve the most significant judgments and estimates used in the preparation of our consolidated financial statements. We evaluate these policies on an ongoing basis, based upon historical results and experience, consultation with experts, trends and other methods we consider reasonable in the particular circumstances, as well as our forecasts as to how these might change in the future.

 

Warranties

 

Estimated product warranty expenses are accrued in selling expenses at the time the related sales are recognized. We base our estimate on historical trends of units sold and payment amounts, combined with our current understanding of the status of existing claims and discussions with our customers.

 

Inventories

 

Inventories are stated at the lower of cost or net realizable value. Cost is calculated on the weighted-average basis and includes all costs to acquire and other costs incurred in bringing the inventories to their present location and condition. The Company evaluates the net realizable value of its inventories on a regular basis and records a provision for loss to reduce the computed weighted-average cost if it exceeds the net realizable value.

 

Income Taxes

 

Taxes are calculated in accordance with taxation principles currently effective in the PRC. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or loss in the period that includes the enactment date. A valuation allowance is provided for the amount of deferred tax assets and liabilities that, based on available evidence, are not expected to be realized.

 

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 ended December 31, 2007 and 2008, the Joint Venture was entitled to an income tax exemption on all pre-tax income generated by the company above its pre-tax income generated in the year ended December 31, 2006. Thereafter, the Joint Venture was entitled to a 50% exemption from the effective income tax rate on any pre-tax income above its 2006 pre-tax income, to be recognized in the years ended December 31, 2009, 2010 and 2011. However, the above tax exemption was superseded, as a result of the fact that 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 from the year ended December 31, 2009 through the year ended December 31, 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 "High-Tech Enterprise" designation by the government, according to relevant PRC income tax laws. Accordingly, it was taxed at a 15% rate through the year ended December 31, 2014. In 2015, the Joint Venture was awarded the Chinese government's "High-Tech Enterprise" designation for a third time, which is valid for three years and it continued to be taxed at the 15% tax rate in 2016 and 2017.

 

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Revenue Recognition

 

In accordance with the provisions of Staff Accounting Bulletin No. 103, revenue from the sale of goods is recognized when the risks and rewards of ownership of the goods have transferred to the buyer including factors such as when persuasive evidence of an arrangement exits, delivery has occurred, the sales price is fixed and determinable, and collection is probable. The Company generally records sales upon shipment of product to customers and transfer of title under standard commercial terms. Revenue consists of the invoice value for the sale of goods and services net of value-added tax (“VAT”), rebates and discounts and returns. The Company nets sales return in gross revenue, i.e., the revenue shown in the income statement is the net sales. The Company is subject to the following surtaxes, which are recorded as deductions from gross sales: Education Tax and City Construction Tax.

 

The Company does not receive revenue for shipping and handling costs to customers. Shipping and handling expenses incurred by the Company are included in selling and administrative expenses in the accompanying consolidated statements of income.

 

FACTORS THAT MAY INFLUENCE RESULTS OF OPERATIONS

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of accounts receivable. The Company performs ongoing credit evaluations with respect to the financial condition of its creditors, but does not require collateral. In order to determine the value of the Company’s accounts receivable, the Company records a provision for doubtful accounts to cover probable credit losses. Management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collection of outstanding accounts receivable.

 

RESULTS OF OPERATIONS

 

Revenue

 

The year ended December 31, 2017 as compared to the year ended December 31, 2016:

 

   Years Ended December 31, 
Sales  2017   Percent of
Total sales
   2016   Percent of
Total sales
 
  (U.S.  dollars in millions) 
Commercial vehicle brake systems, etc.  $330.2    84.6%  $224.2    80.4%
Passenger vehicle brake systems, etc.  $60.3    15.4%  $54.5    19.6%
                     
Total  $390.5    100.0%  $278.7    100.0%

 

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Total sales were $390.5 million and $278.7 million for the years ended December 31, 2017 and 2016, respectively, representing an increase of $111.8 million or 40.1% year over year. The increase was mainly due to the increased sales of commercial vehicle brake systems to China OEM market and aftermarket. 

 

The sales from commercial vehicle brake systems increased by $106 million or 47.3%, to $330.2 million for the year ended December 31, 2017, compared to $224.2 million for the year ended December 31, 2016. 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 $5.8 million or 10.6%, to $60.3 million for the year ended December 31, 2017, compared to $54.5 million for the year December 31, 2016. The increase was mainly due to the increase of passenger vehicle market.

 

A breakdown of sales revenue for our three principal markets, Chinese OEM market, Chinese Aftermarket and International Market, in 2017 and 2016 is as follows:

 

   Years Ended December 31,     
      Percent of      Percent of   Percentage 
   2017   Total sales   2016   Total sales   Change 
   (U.S. dollars in millions)     
Chinese OEM market  $

180.1

    46.1%  $118.4    42.5%   52.0%
China Aftermarket  $

138.4

    35.4%  $100.9    36.2%   37.2%
International market  $72.0    18.5%  $59.4    21.3%   21.3%
                          
Total  $390.5    100.0%  $278.7    100.0%   40.1%

 

With the increase of the production and sales of the commercial vehicle market, our sales to the Chinese OEM market increased by $61.6 million or 52.0%, from $118.4 million in 2016, to $180.1 million in 2017.

 

Our sales to the Chinese aftermarket increased by $37.5 million or 37.2%, to $138.4 million for the year of 2017, compared to $100.9 million for the year of 2016. The increased new vehicle sales in China and the expiration of OEM warranties helped to drive our aftermarket business. Accelerated urbanization and the Chinese government’s increased support for public transportation favor our expansion in the bus aftermarket. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets.

 

Our export sales increased by $12.7 million or 21.3%, to $72.0 million for the year of 2017, as compared to $59.4 million for the year of 2016. The increase in export sales was mainly due to our broadened customer base.

 

Cost of Sales and Gross Profit

 

Cost of sales for the year ended December 31, 2017 increased to $286.3 million from $203.4 million for the year ended December 31, 2016, an increase of $83.0 million, or 40.8%.

 

Gross profit for the year ended December 31, 2017, increased by $28.8 million or 38.2% to $104.2 million from $75.4 million for the year ended December 31, 2016, as a result of the increased sales.

 

Gross margin decreased by approximately 0.3%, from 27.0% in 2016 to 26.7% in 2017. To strengthen our competitiveness and increase our market share, we would enhanced the price promotion in the 2018.

 

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Cost of sales from commercial vehicle brake systems for the year ended December 31, 2017 were $240.8 million, an increase of $79.6 million or 49.4%, from $161.2 million for the year ended December 31, 2016. The gross profit from commercial vehicle brake systems increased by 41.7% to $89.4 million for the year ended December 31, 2017 from $63.1 million for the year of 2016. Gross margin from commercial vehicle brake systems decreased to 27.1% for the year ended December 31, 2017 from 28.1% in 2016. We intend to focus in 2018 on increasing production efficiency, improving the technologies of products, and improving our product portfolio, to help us increase our gross profit margins.

 

Cost of sales from passenger vehicle brake systems for the year ended December 31, 2017 were $45.5 million, an increase of $3.3 million or 7.8% from $42.2 million for the year ended December 31, 2016. The gross profit from passenger vehicle brake systems increased by 20.2% to $14.8 million for the year of 2017 from $12.3 million for the year of 2016. Gross margin from passenger vehicle brake systems increased to 24.6% for the year ended December 31, 2017 from 22.6% in 2016. To strengthen our competitiveness and increase our market share, we started the price promotion in the aftermarket and international market for the year ended December 31, 2017.

 

Selling Expenses

 

Selling expenses were $39.1 million for the year ended December 31, 2017, as compared to $29.8 million for the year ended December 31, 2016, an increase of $9.2 million or 30.9%. The increase was mainly due to increased freight expense and packaging expenses as well as increased compensation for sales employees with the increase in sales. As a percentage of sales revenue, selling expenses decreased to 10.0% for the year ended December 31, 2017, as compared to 10.7% for the same period in 2016. 

 

General and Administrative Expenses

 

General and administrative expenses were $22.0 million for the year ended December 31, 2017, as compared to $15.2 million for the year ended December 31, 2016, an increase of $6.8 million or 44.8 %. The increase was mainly due to the increased sales. As a percentage of sales revenue, general and administrative expenses increased to 5.6% for the year ended December 31, 2017, as compared to 5.5% for the same period in 2016. 

 

Research and Development Expense

 

Research and development expense was $11.0 million for the year ended December 31, 2017, as compared with $7.7 million for the year ended December 31, 2016, an increase of $3.3 million or 42.7%. The Company expects to continue to invest in new product development, particularly in upgrading traditional products and developing electronically controlled products.

 

Other Operating Income

 

For the year ended December 31, 2017, other operating income was $3.0 million compared with $0.6 million for the year ended December 31, 2016, an increase of $2.4 million or 446.8%. The increase was due to an increase in sales of raw material scrap for the year ended December 31, 2017.

 

Depreciation and Amortization

 

Depreciation and amortization expense increased to $9.3 million for the year ended December 31, 2017, compared with depreciation and amortization expense of $7.2 million for the year ended December 31, 2016. The increase in depreciation and amortization expense was due to the higher acquisitions of plant, property, equipment and land use rights.

 

Interest Income

 

Interest income for the year ended December 31, 2017, decreased by $0.8 million to $0.2 million from $1.0 million for the year of 2016, mainly due to decrease in short term investments during the year.

 

Interest Expenses

 

The interest expenses for the year ended December 31, 2017 increased by $2.2 million to $3.1 million from $0.9 million for the year of 2016, mainly due to increased interest rate and increased amount of average loans outstanding during the year.

 

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.

 

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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. 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 by the government, according to the relevant PRC income tax laws. Accordingly, it was taxed at a 15% rate in 2012 through 2014. 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.

 

Income tax expense of $4.7 million and $3.3 million was recorded for the year of 2017 and 2016, respectively.

 

Net Income Attributable to Non-controlling Interest in Subsidiaries 

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian. Net income attributable to non-controlling interest in subsidiaries amounted to $2.7 million and $2.1 million for the years ended December 31, 2017 and 2016, respectively.

 

Net Income Attributable To Stockholders 

 

The net income attributable to stockholders for the year ended December 31, 2017 increased by $5.1 million, to $24.3 million from $19.2 million for the year ended December 31, 2016 due to the increase in our sales and gross profit. Earnings per share (“EPS”), both basic and diluted, for 2017 and 2016, were $1.26 and $1.00 per share, respectively.

 

LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS

 

As of December 31, 2017, the Company had cash and cash equivalents of $4.2 million, a decrease of $3.8 million, as compared to cash and cash equivalents of $8.1 million at December 31, 2016. The Company had working capital of $111.4 million at December 31, 2017, an increase of $59.1 million as compared to working capital of $97.1 million at December 31, 2016, reflecting current ratios of 1.3:1 and 1.7:1, respectively.

 

OPERATING - Net cash provided by operating activities was $33.8 million for the year ended December 31, 2017, as compared to $5.4 million of net cash provided by operating activities for the year ended December 31, 2016, an increase of $28.4 million, primarily due to the increased cash inflows as a result of the change in deposits received from customers and accounts payable and bank acceptance notes to vendors.

 

INVESTING - For the year ended December 31, 2017, the Company used net cash of $120.6 million in investing activities mainly for acquisition of plant, property, equipment and land use rights, and also advances to related parties. During the year ended December 31, 2016, the Company generated net cash of $38.2 million in investing activities mainly for proceeds from short term investments.

 

FINANCING – For the year ended December 31, 2017, net cash provided by financing activities was $82.6 million. Net cash used by financing activities was $66.8 million for the year ended December 31, 2016.

 

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 in the foreseeable future.

 

OFF-BALANCE SHEET AGREEMENTS

 

As of December 31, 2017 and December 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 from the Ruili Group, a related party. The Company also purchased the buildings on the land in the same transaction. The purchase price of land use right and building amounted to approximately $20 million. On May 5, 2016, the Company entered into a Purchase Agreement with the Ruili Group through Ruian, pursuant to which the Company agreed to exchange the Dongshan Facility plus RMB 501 million (approximately $76.5 million) in cash for Development Zone Facility. The value for the Dongshan Facility and Development Zone Facility were appraised to be RMB 125 million (approximately $19.1 million) and RMB 626 million (approximately $95.6 million), respectively. As of December 31, 2017, total amount of RMB 481 million (approximately 73.5 million) was paid to the Ruili Group in installments, and the remaining RMB 20 million (approximately $3.0 million) will be paid within 10 days of completion of the required procedures for transferring the title of the facilities and the land use rights as specified in the Purchase Agreement.

 

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

 

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

 

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

 

c)The Company has reserved tax payables in the amount of RMB 19,590,000 (approximately $2,891,580) on its consolidated balance sheets under the line item “accrued expenses” as if no reduction or exemption of tax is approved. This amount was determined based on a 3% tax rate on the consideration paid for the land use right in the transaction, which the Company considered as the most probable amount of tax liability. This amount also represented the maximum amount of tax the Company expects to pay if the negotiation with the local government ultimately is not successful.

 

CONTRACTUAL OBLIGATIONS 

 

As of December 31, 2017, we had no material changes outside the ordinary course of business in our contractual obligations.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company did not have any material market risk with respect to such factors as commodity prices, equity prices, and other market changes that affect market risk sensitive investments.

 

Although our reporting currency is the U.S. dollar, the functional currency of Joint Venture is primarily RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. In prior years, the RMB had been appreciating against the U.S. dollar. During the last couple of years, the RMB started to depreciate against the U.S. dollars.

 

Assets and liabilities of our operating subsidiaries are translated into U.S. dollars at the exchange rate at the balance sheet date, their equity accounts are translated at historical exchange rate and their income and expenses are translated using the average rate for the period. Therefore, we are subject to foreign exchange risk. Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. The Company is adopting strategies to reduce the foreign exchange risk, such as diversifying currencies used in export sales, and negotiating of export contracts with fixed exchange rates. However, we cannot accurately predict future exchange rates or the overall impact of future exchange rate fluctuations on our business results of operations and financial condition.

 

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

 

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ITEM 8 FINANCAL STATEMENTS AND SUPPLEMENTARY DATA

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the shareholders and board of directors of

SORL Auto Parts, Inc. and Subsidiaries

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of SORL Auto Parts, Inc. and Subsidiaries (collectively, the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “financial statements”). We have also audited the parent company financial statements for the years ended December 31, 2017 and 2016 included in Schedule I. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related parent company financial statements included in Schedule I, when considered in relation to the financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

 

Basis for Opinion

 

These financial statements and parent company financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements and the parent company financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ MaloneBailey, LLP  
www.malonebailey.com  
We have served as the Company’s auditor since 2013.  
Houston, Texas  
April 2, 2018  

  

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SORL Auto Parts, Inc. and Subsidiaries

Consolidated Balance Sheets

December 31, 2017 and December 31, 2016

 

   December 31, 2017   December 31, 2016 
Assets          
Current Assets          
Cash and cash equivalents  US$4,221,940   US$8,057,155 
Accounts receivable, net, including $1,297,734 and $5,025,509 from related parties at December 31, 2017 and 2016, respectively   134,384,961    102,129,294 
Bank acceptance notes from customers   116,040,688    42,697,276 
Inventories   114,300,564    65,776,517 
Prepayments, current, including $999,527 and $- to related party at December 31, 2017 and 2016, respectively   8,826,004    10,797,601 
Restricted cash   376,236    5,476,621 
Advances to related parties   72,318,224    - 
Other current assets, net   5,555,568    1,124,608 
Total Current Assets   456,024,185    236,059,072 
           
Property, plant and equipment, net   79,828,006    53,737,706 
Land use rights, net   14,912,134    8,309,333 
Intangible assets, net   3,341    11,438 
Deposits on loan agreements   10,712,865    - 
Prepayments, non-current   16,594,987    - 
Deferred tax assets   4,240,424    3,210,575 
Total Non-Current Assets   126,291,757    65,269,052 
Total Assets  US$582,315,942   US$301,328,124 
           
Liabilities and Equity          
Current Liabilities          
Accounts payable and bank acceptance notes to vendors, including $15,896,804 and $1,953,707 payable to related parties at December 31, 2017 and 2016, respectively  US$118,051,633   US$65,672,626 
Deposits received from customers   43,087,473    22,733,742 
Short term bank loans   125,380,899    27,416,376 
Current portion of long term loans   24,266,031    - 
Income tax payable   3,249,727    996,522 
Accrued expenses   25,154,658    20,103,392 
Deferred income   1,020,273    - 
Due to related party   1,572,963    - 
Other current liabilities   2,857,130    2,013,943 
Total Current Liabilities   344,640,787    138,936,601 
           
Long term loans, less current portion and net of unamortized debt issuance costs   37,383,224    - 
Total Non-Current Liabilities   37,383,224    - 
Total Liabilities   382,024,011    138,936,601 
           
Equity          
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of December 31, 2017 and 2016   -    - 
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of December 31, 2017 and 2016   38,609    38,609 
Additional paid-in capital   (28,582,654)   (28,582,654)
Reserves   17,562,357    15,129,935 
Accumulated other comprehensive income   15,903,188    6,117,042 
Retained earnings   168,244,329    146,352,530 
Total SORL Auto Parts, Inc. Stockholders' Equity   173,165,829    139,055,462 
Noncontrolling Interest In Subsidiaries   27,126,102    23,336,061 
Total Equity   200,291,931    162,391,523 
Total Liabilities and Equity  US$582,315,942   US$301,328,124 

 

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

 

 35 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Income and Comprehensive Income

For the Years Ended December 31, 2017 and 2016

 

   2017   2016 
         
Sales  US$ 390,522,569    US$ 278,743,122  
Include: sales to related parties   24,376,622    20,289,371 
Cost of sales   286,336,367    203,353,086 
Gross profit   104,186,202    75,390,036 
           
Expenses:          
Selling and distribution expenses   39,067,566    29,837,757 
General and administrative expenses   22,023,338    15,206,423 
Research and development expenses   11,004,560    7,709,533 
Total operating expenses   72,095,464    52,753,713 
           
Other operating income, net   3,039,824    555,946 
           
Income from operations   35,130,562    23,192,269 
           
Interest income   232,466    1,047,667 
Government grants   2,264,055    832,264 
Other income   101,475    1,244,078 
Interest expenses   (3,100,396)   (887,097)
Other expenses   (2,883,440)   (807,858)
           
Income before income taxes provision   31,744,722    24,621,323 
           
Income taxes provision   4,717,810    3,266,413 
           
Net income  US$27,026,912   US$ 21,354,910  
           
Net income attributable to noncontrolling interest in subsidiaries   2,702,691    2,135,516 
           
Net income attributable to common stockholders  US$24,324,221   US$ 19,219,394  
           
Comprehensive income:          
           
Net income  US$27,026,912   US$ 21,354,910  
Foreign currency translation adjustments   10,873,496    (10,606,219)
Comprehensive income   37,900,408    10,748,691 
Comprehensive income attributable to noncontrolling interest in subsidiaries   3,790,041    1,074,894 
Comprehensive income attributable to common stockholders  US$ 34,110,367    US$9,673,797  
           
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$1.26    US$ 1.00  
           
EPS - diluted  US$ 1.26    US$ 1.00  

 

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

 

 36 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2017 and 2016

 

   2017   2016 
         
Cash Flows From Operating Activities          
Net income  US$27,026,912   US$21,354,910 
Adjustments to reconcile net income to net cash provided by operating activities:          
           
Allowance for doubtful accounts   1,474,872    395,491 
Depreciation and amortization   9,259,516    7,239,908 
Deferred income tax   (807,058)   (502,903)
Loss on disposal of property and equipment   9,515    - 
Changes in assets and liabilities:          
Account receivable   (26,640,753)   (39,422,631)
Bank acceptance notes from customers   (3,197,464)   (21,991,160)
Other currents assets   (4,371,425)   (291,979)
Inventories   (43,139,593)   3,281,901 
Prepayments   1,877,272    (7,366,749)
Prepaid capital lease interest   -    90,373 
Accounts payable and bank acceptance notes to vendors   46,444,126    31,988,447 
Income tax payable   2,126,238    1,314,808 
Deposits received from customers   18,302,544    4,135,536 
Deferred income   989,766    - 
Other current liabilities and accrued expenses   4,466,181    5,201,618 
Net Cash Flows Provided By Operating Activities   33,820,649    5,427,570 
           
Cash Flows From Investing Activities          
Change in short term investments   -    58,993,591 
Deposits on loan agreements   (5,196,271)   - 
Acquisition of property, equipment, plant and land use rights   (52,259,319)   (15,889,693)
Deposits for acquisition of land use rights   (2,982,537)   - 
Refund of deposits for acquisition of land use rights   2,982,537    - 
Advances to related parties   (186,885,309)   (18,247,384)
Repayment of advances to related parties   118,436,661    18,247,384 
Change in restricted cash   5,275,390    (4,897,377)
Net Cash Flows Provided By (Used In) Investing Activities   (120,628,848)   38,206,521 
           
Cash Flows From Financing Activities          
Proceeds from short term bank loans   206,836,188    53,895,058 
Repayment of short term bank loans   (113,440,430)   (48,153,831)
Proceeds from related parties   103,775,545    - 
Repayments to related parties   (139,482,122)   - 
Proceeds from long term loans   29,692,975    - 
Repayment of long term loans   (3,008,756)   - 
Payment of debt issuance costs   (1,767,572)   - 
Distribution to controlling shareholders in connection with plant and land use rights exchange with entity under common control   -    (70,781,668)
Repayment of capital lease   -    (1,779,040)
Net Cash Flows Provided By (Used In) Financing Activities   82,605,828    (66,819,481)
           
Effects on changes in foreign exchange rate   367,156    1,011,717 
           
Net change in cash and cash equivalents   (3,835,215)   (22,173,673)
           
Cash and cash equivalents- beginning of the year   8,057,155    30,230,828 
           
Cash and cash equivalents - end of the year  US$4,221,940   US$8,057,155 
           
Supplemental Cash Flow Disclosures:          
Interest paid  US$2,860,931   US$807,587 
Income taxes paid  US$3,398,629   US$3,284,070 
           
Non-cash Investing and Financing Transactions          
Transfer of plant and land use rights to entity under common control  US$-   US$17,342,372 
Liabilities assumed in connection with the plant and land use rights exchange  US$-   US$5,351,196 
Proceeds from long term loans in the form of bank acceptance notes  US$29,692,975   US$- 
Loans from related party in the form of bank acceptance notes  US$35,706,576   US$- 
Transfer of debt among related parties  US$3,711,622   US$- 
Deposits on loan agreements deducted from proceeds from long term loans  US$5,196,271   US$- 

   

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

 

 37 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Equity

For the Years Ended December 31, 2017 and 2016

 

   Number
of Share
   Common
Stock
   Additional
Paid-in
Capital
   Reserves   Retained
Earnings
   Accumulated
Other
Comprehensive
Income
   Total SORL
Auto
Parts, Inc.
Stockholders’
Equity
   Noncontrolling
Interest
   Total Equity 
Balance as of 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   -    -    -    -    19,219,394    -    19,219,394    2,135,516    21,354,910 
                                              
Foreign currency translation adjustment   -    -    -    -    -    (9,545,597)   (9,545,597)   (1,060,622)   (10,606,219)
                                              
Distribution to controlling shareholders in connection with plant and land use rights exchange with entity under common control   -    -    (70,781,668)   -    -    -    (70,781,668)   -    (70,781,668)
                                              
Transfer to reserve   -    -    -    1,921,963    (1,921,963)   -    -    -    - 
Balance as of December 31, 2016   19,304,921   $38,609    $(28,582,654)  $15,129,935   $146,352,530   $6,117,042   $139,055,462   $23,336,061   $162,391,523 
                                              
Net income   -    -    -    -    24,324,221    -    24,324,221    2,702,691    27,026,912 
                                              
Foreign currency translation adjustment   -    -    -    -    -    9,786,146    9,786,146    1,087,350    10,873,496 
                                              
Transfer to reserve   -    -    -    2,432,422    (2,432,422)   -    -    -    - 
Balance as of December 31, 2017   19,304,921   $38,609   $(28,582,654)  $17,562,357   $168,244,329   $15,903,188   $173,165,829   $27,126,102   $200,291,931 

 

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

 

 38 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 - 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 2,000 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. After this transaction, SIH ceased to be a distributor of SORL in the international market.

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

a.ACCOUNTING METHOD

 

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

 

b.PRINCIPLES OF CONSOLIDATION

 

The consolidated financial statements include the accounts of SORL Auto Parts, Inc. and its majority owned subsidiaries. All inter-company balances and transactions have been eliminated in the consolidation. The results of subsidiaries acquired or disposed of during the respective periods are included in the consolidated statements of income and comprehensive income from the effective date of acquisition or up to the effective date of disposal, as appropriate. The portion of the income or loss applicable to non-controlling interests in subsidiary undertakings is reflected in the consolidated statements of income and comprehensive income.

 

c.USE OF ESTIMATES

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) 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.

 

 39 

 

 

d.FAIR VALUE OF FINANCIAL INSTRUMENTS

 

For certain of the Company’s financial instruments, including cash and cash equivalents, restricted cash, accounts receivables and payables, prepaid expenses, other current assets, short term bank loans, current portion of long term loans, deposits received from customers 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, free market 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.

  

e.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.

 

f.FINANCIAL RISK FACTORS AND FINANCIAL RISK MANAGEMENT

 

The Company is exposed to the following risk factors:

 

i)Credit risks – Financial instruments that potentially subject the Company to concentrations of credit risk are cash and cash equivalents and accounts receivable arising from its normal business activities. The Company places its cash and cash equivalents in what it believes to be credit-worthy financial institutions. The Company has policies in place to ensure that sales of products are made to customers with an appropriate credit history. The Company performs ongoing credit evaluations with respect to the financial condition of its creditors, but does not require collateral. In order to determine the value of the Company’s accounts receivable, the Company records a provision for doubtful accounts to cover probable credit losses. Management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collection of outstanding accounts receivable. The Company has a concentration of credit risk due to geographic sales as a majority of its products are marketed and sold in the PRC. The Company has no customer that accounts for more than 10.00% of its total revenues for the year ended December 31, 2017.
ii)Liquidity risks - Prudent liquidity risk management implies maintaining sufficient cash, the availability of funding through an adequate amount of committed credit facilities and ability to close out market positions.
iii)Interest rate risk - The interest rate of short term bank borrowings obtained in 2017 ranged from 1.35% to 5.22% and the term ranged from approximately one month to one year. The Company also obtained long term loans from non-financial institutions for effective interest rates ranging from 4.31% to 8.50%. The Company’s income and cash flows are substantially independent of changes in market interest rates.

 

g.CASH AND CASH EQUIVALENTS

 

The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents.

 

  h. 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. As of December 31, 2016, the term deposits matured and the pledge was released as the credit line was fully paid off by Ruili Group.

 

 40 

 

 

Term deposit in the amount of $6,190,800 (RMB 40,000,000) was pledged as security interest 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. As of December 31, 2016, the term deposit matured and the pledge was released as the bank acceptance notes were paid off by Hangzhou Xiangwei Wuzi Co., Ltd.

 

Term deposit in the amount of $3,317,650 (RMB 22,000,000) was pledged for the credit line granted to Ruili Group, a related party, by Bank of Ningbo for the period from January 13, 2016 to July 13, 2016. As of December 31, 2016, the term deposit matured and the pledge was released as the credit line was fully paid off by Ruili Group.

  

i.RESTRICTED CASH

 

In 2016, the 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. In 2017, with the change of the issuing banks, the Company is no longer required to make initial deposits for issuing bank acceptance notes. The restricted cash was mainly required as a deposit for obtaining a letter of credit from Industrial Bank Co., Ltd., which agreed to provide guarantee that the Company would pay on time to the sellers in the case of any purchases.

 

j.INVENTORIES

 

Inventories are stated at the lower of cost or net realizable value, with cost computed on a weighted-average basis. Cost includes all costs of purchase, cost of conversion and other costs incurred in bringing the inventories to their present location and condition. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

 

k.PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment are stated at cost less accumulated depreciation and impairment losses. The initial cost of the asset comprises its purchase price and any directly attributable costs of bringing the asset to its working condition and location for its intended use. Depreciation is calculated using the straight-line method over the estimated useful life of the respective assets as follows:

 

Category   Estimated Useful Life (Years)
Buildings   10-20
Machinery and equipment   5-10
Electronic equipment   5
Motor vehicles   5-10
Leasehold improvements   The lesser of remaining lease term or 10

 

 41 

 

 

Significant improvements are capitalized when it is probable that the expenditure resulted in an increase in the future economic benefits expected to be obtained from the use of the asset beyond its originally assessed standard of performance. When improvements are made to real property and those improvements are permanently affixed to the property, the title to those improvements automatically transfers to the owner of the property. The lessee’s interest in the improvements is not a direct ownership interest but rather it is an intangible right to use and benefit from the improvements during the term of the lease.

 

Routine repairs and maintenance are expensed when incurred. Gains and losses on disposal of fixed assets are recognized in the income statement based on the net disposal proceeds less the carrying amount of the assets.

 

l.LAND USE RIGHTS

 

According to the law of China, the government owns all the land in China. Companies or individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. Land use rights are being amortized using the straight-line method over the estimated useful life of 40 years.

 

m.IMPAIRMENT OF LONG-LIVED ASSETS

 

Long-lived assets, such as property, plant and equipment and other non-current assets, including intangible assets, are reviewed periodically for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss is recognized when the estimated undiscounted cash flows associated with the asset or group of assets is less than their carrying value. If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. Assets to be disposed of are carried at the lower of carrying value or estimated net realizable value.

 

n.ACCOUNTS RECEIVABLES AND ALLOWANCE FOR BAD DEBTS

 

The Company presents accounts receivables, net of allowances for doubtful accounts and returns, to ensure accounts receivable are not overstated due to being uncollectible.

 

The allowances are calculated based on a detailed review of certain individual customer accounts, historical collectability rates, a general provision based on aging and an estimation of the overall economic conditions affecting the Company’s customer base. The Company reviews a customer’s credit history before extending credit. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

The Company will write off the uncollectible receivables once any customers are bankrupt or there is a remote possibility that the Company will collect the outstanding balance. The write-off must be reported to the local tax authorities and the Company must receive official approval from them. To date, the Company has not written off any account receivables.

 

 42 

 

 

 

  o. NOTES RECEIVABLE

 

Notes receivable, generally due within twelve 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 December 31, 2017 and 2016, notes receivables in the amount of $95,914,724 and $32,916,198, respectively, were pledged to endorsing banks to issue bank acceptance notes or short term bank loans. The banks charge discount fees if the Company chooses to discount the notes receivables for cash before the maturity of the notes. The Company incurred discount fees of $37,177 and $135,329 for the years ended December 31, 2017 and 2016, respectively, which were included in interest expenses.

 

  p. REVENUE RECOGNITION

 

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

 

  q. INCOME TAXES

 

The Company accounts for income taxes under the provision of FASB ASC 740-10, Income Taxes, or ASC 740-10, whereby deferred income tax assets and liabilities are computed for differences between the financial statements and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary; to reduce deferred income tax assets to the amount expected to be realized.

 

  r. 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, U.S. dollars (“US$”). All assets and liabilities are translated at the current rate. The stockholders’ equity accounts are translated at appropriate historical rate. Revenue and expenses are translated at average exchange rates during the period.

 

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

 

  s. EMPLOYEES’ BENEFITS

 

Mandatory contributions are made to government’s health, retirement benefit and unemployment schemes at the statutory rates in force during the period, based on gross salary payments. The cost of these payments is charged to the statement of income in the same period as the related salary costs.

 

  t. RESEARCH AND DEVELOPMENT EXPENSES

 

Research and development costs are classified as general and administrative expenses and are expensed as incurred. Research and development expenses were $11,004,560 for the year ended December 31, 2017, as compared with $7,709,533 for the year ended December 31, 2016.

 

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  u. SHIPPING AND HANDLING COSTS

 

Shipping and handling cost are classified as selling expenses and are expensed as incurred. Shipping and handling costs were $7,094,863 and $6,529,999 for the years ended December 31, 2017 and 2016, respectively.

 

  v. ADVERTISING COSTS

 

Advertising costs are classified as selling expenses and are expensed as incurred. Advertising costs were $440,582 and $239,301 for the years ended December 31, 2017 and 2016, respectively.

 

  w. WARRANTY CLAIMS

 

The Company provides for the estimated cost of product warranties when the products are sold. Such estimates of product warranties were based on, among other things, historical experience, product changes, material expenses, and service and transportation expenses arising from the manufactured product. Estimates will be adjusted on the basis of actual claims and circumstances. Warranty claims were $1,570,290 and $2,503,950 for the years ended December 31, 2017 and 2016, respectively.

 

  x. PURCHASE DISCOUNTS

 

Purchase discounts represent discounts received from vendors for purchasing raw materials and are netted in the cost of goods sold, if applicable.

 

  y. LEASE COMMITMENTS

 

The Company has adopted FASB Accounting Standard Codification, or ASC 840, Lease. If the lease terms meet one or all of the following four criteria, it will be classified as a capital lease, otherwise, it is an operating lease: (1) The lease transfers the title to the lessee at the end of the term; (2) the lease contains a bargain purchase option; (3) the lease term is equal to 75% of the estimated economic life of the leased property or more; (4) the present value of the minimum lease payment in the term equals or exceeds 90% of the fair value of the leased property.

 

  z. 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.

 

  aa. GOVERNMENT GRANTS

 

Government grants include cash subsidies as well as other subsidies received from the PRC government by the Joint Venture. Such subsidies are generally provided as incentives from the local government to encourage the expansion of local business. Government grants are recognized when received and all the conditions specified in the grant have been met. Capital grants received in advance of the acquisition of equipment are recorded initially in deferred income and then offset against the cost of the related equipment upon acquisition.

 

  bb. SEGMENT REPORTING

 

ASC Topic 280 requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. During the years ended December 31, 2017 and 2016, the Company operated in two reportable business segments: (1) commercial vehicles brake systems (2) passenger vehicles brake systems.

 

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  cc. RECENTLY ISSUED FINANCIAL STANDARDS

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (ASC 606)”. Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is effective for fiscal years and interim periods within those years beginning after December 15, 2017, and early adoption is permitted for periods beginning after December 15, 2016. The Company elected to adopt the new standard effective January 1, 2018.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). The Company elected adopting the standard using the full retrospective method to restate prior reporting period presented. The Company has identified its revenue streams and assessed each for the impacts. The Company expects the adoption of Topic 606 will not have a material impact in the timing or amount of revenue recognized, including the presentation of revenues in the Company’s consolidated statements of income.

 

In November 2015, the FASB issued ASU 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes”. The amendments in ASU 2015-17 eliminates the current requirement for organizations to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, organizations will be required to classify all deferred tax assets and liabilities as noncurrent. The amendments in this ASU are effective for public business entities for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The amendments may be applied prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company adopted this amendment from January 1, 2017. The adoption did not have an impact on our consolidated financial statements and related disclosures other than for reclassification.

 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”. ASU 2016-02 specifies the accounting for leases. For operating leases, ASU 2016-02 requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, on its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. In addition, this standard requires both lessees and lessors to disclose certain key information about lease transactions. ASU 2016-02 is effective for publicly-traded companies for annual reporting periods, and interim periods within those years, beginning after December 15, 2018. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. The Company plans to adopt the standard effective January 1, 2019. The Company anticipates this standard will not have a material impact on the Company’s consolidated financial statements.

 

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. These amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments do not provide a definition of restricted cash or restricted cash equivalents. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company elected to adopt the standard effective January 1, 2018 and anticipates this standard will not have a material impact on the Company’s consolidated statements of cash flows.

 

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In January 2017, the FASB issued ASU 2017-03, “Accounting Changes and Error Corrections (Topic 250) and Investments - Equity Method and Joint Ventures (Topic 323)”. This pronouncement amends the SEC’s reporting requirements for public filers in regard to new accounting pronouncements or existing pronouncements that have not yet been adopted. Companies are to provide qualitative disclosures if they have not yet implemented an accounting standards update. Companies should disclose if they are unable to estimate the impact of a specific pronouncement, and provide disclosures including a description of the effect on accounting policies that the registrant expects to apply. These provisions apply to all pronouncements that have not yet been implemented by registrants. There are additional provisions that relate to corrections to several other prior FASB pronouncements. The Company has incorporated language into other recently issued accounting pronouncement notes, where relevant for the corrections in ASU 2017-03. The Company is implementing the updated SEC requirements on not yet adopted accounting pronouncements with these consolidated financial statements.

 

In February 2018, the FASB issued ASU 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”. These amendments provide financial statement preparers with an option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) is recorded. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption of ASU 2018-02 is permitted, including adoption in any interim period for the public business entities for reporting periods for which financial statements have not yet been issued. The amendments in this ASU should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The Company is currently evaluating the impact of the adoption of ASU No. 2018-02 on its consolidated financial statements.

 

In March 2018, the FASB issued ASU 2018-05, “Income Taxes (Topic 740) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118”. The amendments in this ASU add SEC paragraphs pursuant to the SEC Staff Accounting Bulletin No. 118, which expresses the view of the staff regarding application of Topic 740, Income Taxes, in the reporting period that includes December 22, 2017 - the date on which the Tax Cuts and Jobs Act was signed into law. The amendments are effective upon addition to the FASB Accounting Standards Codification. The Company is currently evaluating the impact of the adoption of this guidance on the Consolidated Financial Statements.

 

NOTE 3 - 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 4 - RELATED PARTY TRANSACTIONS

 

Related parties with whom the Company conducted business consist of the following:

 

Name of Related Party   Nature of Relationship
Xiao Ping Zhang   Principal shareholder, Chairman of the Board and Chief Executive Officer)
     
Shu Ping Chi   Shareholder, member of the Board, wife of Xiao Ping Zhang
     
Xiao Feng Zhang   Shareholder, member of the Board, brother of Xiao Ping Zhang
     
Ruili Group Co., Ltd. ("Ruili Group")   10% shareholder of Joint Venture and is collectively controlled by Xiao Ping Zhang, Shu Ping Chi, and Xiao Feng Zhang.
     
Guangzhou Ruili Kormee Automotive Electronic Control Technology Co., Ltd. ("Guangzhou Kormee")   Controlled by Ruili Group
     
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd. (formerly known as “Ruian Kormee Automobile Braking Co., Ltd.”, "Ruian Kormee")   Wholly controlled by Guangzhou Kormee
     
Shanghai Dachao Electric Technology Co., Ltd. ("Shanghai Dachao")   Ruili Group holds 49% of the equity interests in Shanghai Dachao.
     
Ruili MeiLian Air Management System (LangFang) Co., Ltd. ("Ruili Meilian")   Controlled by Ruili Group
     
Wenzhou Lichuang Automobile Parts Co., Ltd. ("Wenzhou Lichuang")   Controlled by Ruili Group
     
Ningbo Ruili Equipment Co., Ltd. ("Ningbo Ruili")   Controlled by Ruili Group
     
Shanghai Ruili Real Estate Development Co., Ltd. ("Shanghai Ruili")   Wholly controlled by Ruili Group
     
Kunshan Yuetu Real Estate Development Co., Ltd. ("Kunshan Yuetu")   Collectively owned by Ruili Group and Shu Ping Chi
     
Shanghai Tabouk Auto Components Co., Ltd. ("Shanghai Tabouk")   Collectively owned by Xiao Feng Zhang and Xiao Ping Zhang
     
HangZhou Ruili Property Development Co., Ltd.   Collectively owned by Ruili Group and Xiao Ping Zhang

  

The Company continues to purchase primarily packaging materials from Ruili Group. In addition, the Company purchases automotive components from five other related parties, Guangzhou Kormee, Ruian Kormee, Ruili Meilian, Shanghai Dachao and Wenzhou Lichuang. The Company also purchases molds from Ningbo Ruili used in its production.

 

The Company sells certain automotive products to the Ruili Group. The Company also sells parts to Guangzhou Kormee, Ruian Kormee, Shanghai Tabouk and Ruili Meilian.

 

The following related party transactions occurred for the years ended December 31, 2017 and 2016:

 

For the Years Ended December 31,
   2017   2016 
PURCHASES FROM:          
Guangzhou Ruili Kormee Automative Eletronic Control Technology Co., Ltd.  $4,487,457   $793,861 
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd.   1,357,612    1,329,135 
Shanghai Dachao Electric Technology Co., Ltd.   188,899    1,787,921 
Ruili MeiLian Air Management System (LangFang) Co., Ltd.   4,106,986    110,446 
Ruili Group Co., Ltd.   5,478,853    4,011,206 
Wenzhou Lichuang Auto Parts Co., Ltd.   5,446,212     
Total Purchases  $21,066,019   $8,032,569 
           
SALES TO:          
Guangzhou Ruili Kormee Automative Eletronic Control Technology Co., Ltd.  $7,467,661   $5,781,501 
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd.   135,911    37,325 
Ruili MeiLian Air Management System (LangFang) Co., Ltd.   1,253,664     
Ruili Group Co., Ltd.   14,108,062    13,436,421 
Shanghai Tabouk Auto Components Co., Ltd.   1,411,324    1,034,124 
Total Sales  $24,376,622   $20,289,371 

 

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    December 31,  
    2017     2016  
ACCOUNTS RECEIVABLE                
Ruili Group Co., Ltd.   $     $ 4,361,010  
Guangzhou Ruili Kormee Automotive Electronic Control Technology  Co., Ltd.           664,499  
Shanghai Tabouk Auto Components Co., Ltd.     1,297,734        
                 
Total   $ 1,297,734     $ 5,025,509  
                 
ACCOUNTS PREPAYMENT                
Ningbo Ruili Equipment Co., Ltd.   $ 999,527     $  
                 
    $ 999,527     $  
                 
ADVANCES TO RELATED PARTIES                
Ruili Group Co., Ltd.   $ 5,711,605     $  
Shanghai Ruili Real Estate Development Co., Ltd.     65,069,497        
Kunshan Yuetu Real Estate Development Co., Ltd.     1,537,122     $  
                 
Total   $ 72,318,224     $  
                 
ACCOUNTS PAYABLE TO RELATED PARTIES                
                 
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd.   $     $ 628,310  
Guangzhou Ruili Kormee Automotive Electronic Control Technology  Co., Ltd.     3,414,719        
Shanghai Dachao Electric Technology Co., Ltd.     83,178       100,441  
Ruili MeiLian Air Management System (LangFang) Co., Ltd.     1,993,787       1,224,956  
Wenzhou Lichuang Auto Parts Co., Ltd.     10,405,120        
                 
Total   $ 15,896,804     $ 1,953,707  
                 
DUE TO RELATED PARTY                
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd.   $ 1,572,963     $  
                 
 Total   $ 1,572,963     $  

 

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During the year ended December 31, 2017, the Company advanced to its related parties in the amount of $186,885,309, including $117,296,565 to Ruili Group, $2,185,691 to Ruian Kormee, $65,918,404 to Shanghai Ruili and $1,484,649 to Kunshan Yuetu. Cash repayments received from related parties amounted to $118,436,661, including $115,467,364 from Ruili Group and $2,969,297 from Shanghai Ruili. The effect of changes in foreign exchange rate is $2,109,754. The Company, Ruian Kormee, and Ruili Group agreed that Ruili Group would transfer $3,711,622 in 2017 to Ruian Kormee by adjusting their corresponding balances with the Company, as a result the Company owed $1,572,963 to Ruian Kormee and had advance balance of $5,711,605 from Ruili Group as of December 31, 2017.

 

The advances to Ruili Group and Ruian Kormee are non-interest bearing, unsecured and due on demand. Those advances are usually repaid within 3 months and are in return for their constant financing support provided to the Company. The advances to Shanghai Ruili and Kunshan Yuetu, bearing an interest rate of 5.22% per annum. During the year ended December 31, 2017, the interest income from advances to related parties amounted to $181,272, which has not been paid as of the filing date. During the year ended December 31, 2016, the Company provided an interest-free borrowing of $18,247,384 to Ruili Group. The borrowing was fully repaid as of December 31, 2016.

 

Subsequent to December 31, 2017, the Company continued to provide loans to related parties. See Note 21 for more details.

 

During the year ended December 31, 2017, the Company obtained loans from related parties for working capital purposes. Of the total cash borrowings of $103,775,545, $88,197,285 was obtained from Ruili Group and $15,578,260 from Ruian Kormee. The Company also borrowed the amount of $35,706,576 in the form of bank acceptance notes from Ruili Group. Cash repayments to related parties totaled $139,482,122, including $123,903,862 to Ruili Group and $15,578,260 to Ruian Kormee.

 

As of December 31, 2017, the Company prepaid Ningbo Ruili in the amount of $999,527 for the purchase of molds which are used in production for 2018.

 

The Company also entered into several lease agreements with related parties. See Note 17 for more details.

 

The Company provided a guarantee for the credit line granted to Ruili Group by Bank of Ningbo in the amount of RMB 150,000,000 (approximately $21,623,180) for the period from May 30, 2016 to May 14, 2017. As of December 31, 2017, the guarantee was released as the credit line was fully paid off by Ruili Group.

 

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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 credit line was replaced by the one issued by the same bank in the amount of RMB 40,000,000 (approximately $5,766,181) for a period of 12 months starting on October 24, 2016. The credit line was renewed on October 19, 2017, and the guarantee was accordingly extended by the Company as of December 31, 2017 and will expire on April 18, 2018.

 

The Company provided a guarantee for the credit line granted to Ruili Group by China Guangfa Bank in the amount of RMB 200,000,000 (approximately $28,830,907) for the period from May 22, 2016 to May 22, 2017. As of December 31, 2017, the guarantee was released as the credit line was fully paid off by Ruili Group.

 

The Company provided a guarantee for the credit line granted to Ruili Group by China Guangfa Bank in a maximum amount of RMB 69,000,000 (approximately $10,092,000) for the period from November 16, 2016 to January 16, 2018. The credit line was renewed on December 21, 2017 for a period of 12 months, and the guarantee was accordingly extended by the Company as of December 31, 2017 and will expire on December 20, 2018.

 

The Company provided a guarantee for the credit line granted to Ruili Group by Bank of Ningbo in a maximum amount of RMB 180,000,000 (approximately $26,328,000) for the period from June 30, 2017 to June 30, 2020.

 

The Company has short term bank loans guaranteed or pledged by related parties. See Note 11 for more details.

 

In May 2016, the Company, through its principal subsidiary, entered into a purchase agreement with Ruili Group, pursuant to which the Company agreed to exchange the land use rights and factory facilities located at No. 1169 Yumeng Road, Rui’an Economic Development Zone, Rui’an City, Zhejiang Province, China, purchased from Ruili Group in 2007. See Note 7 for more details.

 

NOTE 5 - ACCOUNTS RECEIVABLE, NET

 

Accounts receivable, net consisted of the following:

 

   December 31, 2017   December 31, 2016 
Accounts receivable  $148,312,117   $113,815,711 
Less: allowance for doubtful accounts   (13,927,156)   (11,686,417)
           
Account receivable balance, net  $134,384,961   $102,129,294 

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the years ended December 31, 2017 and 2016. The changes in the allowance for doubtful accounts at December 31, 2017 and December 31, 2016 were summarized as follows:

 

   December 31, 2017   December 31, 2016 
Beginning balance  $11,686,417   $12,075,402 
Add: Increase to allowance   1,474,872    395,491 
Less: Accounts written off        
Effects on changes in foreign exchange rate   765,867    (784,476)
           
Ending balance  $13,927,156   $11,686,417 

 

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NOTE 6 – INVENTORIES

 

On December 31, 2017 and December 31, 2016, inventories consisted of the following:

 

   December 31, 2017   December 31, 2016 
Raw materials  $27,657,266   $20,121,513 
Work-in-process   40,805,434    14,843,653 
Finished goods   45,837,864    30,811,351 
           
Less: Write-down of inventories        
Total inventories  $114,300,564   $65,776,517 

 

NOTE 7 - PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment, net, consisted of the following, on December 31, 2017 and December 31, 2016:

 

   December 31, 2017   December 31, 2016 
Machinery  $119,296,564   $87,694,677 
Molds   1,338,912    1,257,841 
Office equipment   2,998,443    2,021,982 
Vehicles   3,681,194    2,246,203 
Buildings   20,127,148    15,826,738 
Leasehold improvements   486,834    458,566 
Sub-total   147,929,095    109,506,007 
           
Less: Accumulated depreciation   (68,101,089)   (55,768,301)
           
Property, plant and equipment, net  $79,828,006   $53,737,706 

 

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Depreciation expense charged to operations was $8,871,856 and $6,943,941 for the years ended December 31, 2017 and 2016, respectively.

 

In May 2016, the Company, through its principal operating subsidiary, entered into a Purchase Agreement (the “Purchase Agreement”) with Ruili Group, pursuant to which the Company agreed to exchange the land use rights and factory facilities located at No. 1169 Yumeng Road, Rui'an Economic Development Zone, Rui'an City, Zhejiang Province, China (the “Dongshan Facility”), purchased in 2007 from Ruili Group, plus RMB 501.00 million (approximately $76.50 million) in cash for the land use rights and factory facilities located at No. 2666 Kaifaqu Avenue, Rui’an Economic Development Zone, Rui’an City, Zhejiang Province, China (the “Development Zone Facility”). As of the filing date, the Company has not obtained the property ownership certificate or land use right certificate of the Development Zone Facility. The Company reserved the relevant tax amount of RMB 4.56 million (approximately $0.75 million) for the Dongshan Facility and RMB 15.00 million (approximately $2.30 million) for the Development Zone Facility. These amounts were determined based on a 3% tax rate on the consideration paid for the Dongshan Facility and the Development Zone Facility in the transactions, which the Company considered as the most probable amount of tax liability.

 

In July 2017, Ruian, a subsidiary of the Company, purchased plants and the associated land use rights from Yunding Holding Group Co., Ltd. in cash at the purchase price of RMB 60.06 million (approximately $8.87 million). The total cost including related deed tax and stamp duty is RMB 58.95 million (approximately $8.88 million) net of value-added input tax in association with the purchase, which has been fully paid in cash as of December 31, 2017. The title of the plants and the associated land use rights was transferred in July 2017. The allocated costs for the land use rights and the plants are RMB 42.35 million (approximately $6.38 million) and RMB 16.60 million (approximately $2.50 million), respectively. The plants and associated land use rights will be used to meet Ruian’s growing operational needs and is located in the east side of the International Auto Parts District, Tangxia Town, Ruian City, Zhejiang Province, China with a land use area of 33,141 square meters and a building floor area of 25,016 square meters.

 

NOTE 8 – LAND USE RIGHTS, NET

 

   December 31, 2017   December 31, 2016 
Cost  $15,477,081   $8,473,362 
Less: Accumulated amortization   (564,947)   (164,029)
Land use rights, net  $14,912,134   $8,309,333 

 

According to the law of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government.

 

In connection with the execution of the Purchase Agreement in May 2016, the Company exchanged the Dongshan Facility plus RMB 501.00 million (approximately $76.50 million) in cash for Development Zone Facility, including land use rights with historical value of approximately $8.50 million. As of the filing date, the Company has not obtained the land use right certificate of the Development Zone Facility. Also see Note 7 for more details.

 

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In July 2017, Ruian, a subsidiary of the Company, purchased plants and the associated land use rights from Yunding Holding Group Co., Ltd. in cash at the purchase price of RMB 60.06 million (approximately $8.87 million). The title of the plants and land use rights was transferred in July 2017. The allocated cost for the land use rights is RMB 42.35 million (approximately $6.38 million). Also see Note 7 for more details.

 

During the year ended December 31, 2017, the Company prepaid the amount of RMB 51.81 million (approximately $7.93 million) as full payment and RMB 20.00 million (approximately $3.01 million) as a refundable deposit to purchase the land use rights for the land located at the intersection of Xianghe Road and North Wansong Road, Binhai New District, Rui’an City, Zhejiang Province, China. The deposit was refunded to the Company as of December 31, 2017. As of the filing date, the title to the land use rights has not been transferred. The payment was included in prepayments, non-current in the consolidated balance sheets. Also see Note 9 for details.

 

During the year ended December 31, 2017, the Company prepaid the amount of RMB 14.40 million (approximately $2.14 million) as down payment to purchase the land use rights for the land located at the intersection of Fengjin Road and Wenhua Road, Binhai New District, Rui’an City, Zhejiang Province, China. As of the filing date, the total purchase price of RMB72.02 million (approximately $11.02 million) including the value-added tax has been made, but the title to the land use rights has not been transferred. The down payment was included in prepayments, non-current in the consolidated balance sheets. Also see Note 9 for details.

 

Amortization expenses were $379,121 and $284,717 for the years ended December 31, 2017 and 2016, respectively.

 

NOTE 9 - PREPAYMENTS

 

Prepayments consisted of the following as of December 31, 2017 and December 31, 2016:

 

   December 31, 2017   December 31, 2016 
Raw material suppliers  $8,826,004   $10,797,601 
Equipment and land use rights purchases   16,594,987    - 
           
Total prepayments  $25,420,991   $10,797,601 

 

As of December 31, 2017, prepayments to raw material suppliers totaled $8,826,004, including prepayments to Ningbo Ruili, a related party under common control, in the amount of $999,527. Also see Note 4 for details.

 

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During the year ended December 31, 2017, the Company prepaid the amount of RMB 51.81 million (approximately $7.93 million) to purchase land use rights for the land located at the intersection of Xianghe Road and North Wansong Road, Binhai New District, Rui’an City, Zhejiang Province, China. The Company also prepaid the amount of RMB 14.40 million (approximately $2.14 million) as down payment to purchase the land use rights for the land located at the intersection of Fengjin Road and Wenhua Road, Binhai New District, Rui’an City, Zhejiang Province, China. As of the filing date, neither of the titles to the land use rights mentioned above has been transferred. Also see Note 8 for details.

 

NOTE 10- DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES

 

Deferred tax assets as of December 31, 2017 and December 31, 2016 comprise of the following:

 

   December 31, 2017   December 31, 2016 
Deferred tax assets - noncurrent          
Allowance for doubtful accounts  $2,137,837   $1,798,894 
Revenue (net of cost)   160,766    76,719 
Unpaid accrued expenses   955,287    357,352 
Warranty   986,534    977,610 
Deferred tax assets   4,240,424    3,210,575 
Valuation allowance        
Net deferred tax assets - noncurrent  $4,240,424   $3,210,575 

 

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

 

NOTE 11 – SHORT TERM BANK LOANS

 

Bank loans represented the following as of December 31, 2017 and December 31, 2016:

 

   December 31,  2017   December 31, 2016 
Secured  $125,380,899   $27,416,376 

 

The Company obtained those short term loans from Bank of China, Bank of Ningbo, Agricultural Bank of China, China Zheshang Bank, China Minsheng Bank, Industrial Bank Co., Ltd., Oversea-Chinese Banking Corporation Limited and China Construction Bank, respectively, to finance general working capital and acquire long-lived assets. Interest rate for the loans outstanding as of December 31, 2017 ranged from 0.9% to 5.22% per annum. The maturity dates of the loans existing as of December 31, 2017 ranged from January 4, 2018 to December 19, 2018. As of December 31, 2017 and 2016, the Company’s accounts receivables of $5,472,169 and $4,484,755, respectively, were pledged as collateral under loan arrangements. The interest expenses, including discount fees, were $2,752,579 and $887,097 for the years ended December 31, 2017 and 2016, respectively.

 

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As of December 31, 2017, corporate or personal guarantees provided for those bank loans were as follows:

 

  56,564,323     Pledged with the Company’s bank acceptance notes.
         
  16,594,227     Guaranteed by Ruili Group., a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders.
         
  11,478,069     Pledged by Shanghai Ruili, a related party, with its property. Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders.
         
  5,850,950     Guaranteed by Ruili Group.
         
  7,345,964     Pledged by the Company with its land use rights and property. Guaranteed by Ruili Group, a related party and Ms. Xiao Ping Zhang, the Company’s principal stockholders.
         
  27,547,366     Pledged by HangZhou Ruili Property Development Co., Ltd., a related party, with its property. Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders.

 

NOTE 12 - ACCRUED EXPENSES

 

Accrued expenses consisted of the following as of December 31, 2017 and December 31, 2016:

 

   December 31, 2017   December 31, 2016 
         
Accrued payroll  $11,063,726   $6,267,794 
Accrued warranty expenses   6,576,895    6,517,402 
Other accrued expenses   7,514,037    7,318,196 
Total accrued expenses  $25,154,658   $20,103,392 

 

NOTE 13 – LONG TERM LOANS

 

   December 31, 2017   December 31, 2016 
Aggregate outstanding principal balance  $63,471,308   $ 
Less: unamortized debt issuance costs   (1,822,053)    
Less: current portion   (24,266,031)    
Non-current portion  $37,383,224   $ 

 

 54 

 

 

On November 16, 2017, the Company entered into two identical but independent loan agreements with Far Eastern Horizon Co., Ltd. (“Far Eastern”), each for a term of 36 months and with an effective interest rate of 8.38% per annum, payable monthly in arrears. The total long term obligations under the two agreements amounted to RMB 200,000,000 (approximately $30,608,185), pledged by the Company’s equipment in the original cost of RMB 205,690,574 (approximately $31,479,075). In connection with the loan agreements, the Company paid deposits in cash for an aggregated amount of RMB 35,000,000 (approximately $5,196,271), with an annual interest of 7% for 42 months to be received from Far Eastern. During the year ended December 31, 2017, the total proceeds of long term loans included cash of RMB 100,000,000 or $14,846,488 and bank acceptance notes in the amount of RMB 100,000,000 or $14,846,487. Repayment of principal totaled $1,599,930 for the year ended December 31, 2017. The Company also paid debt issuance costs in cash of $742,324 for the year ended December 31, 2017.

 

In November 2017, the Company entered into four independent loan agreements with COSCO Shipping Leasing Co., Ltd. (“COSCO”) for a term of 36 months each. Two of the agreements were signed on November 30, 2017 with an effective interest rate of 8.50% per annum, payable monthly in arrears. The other two agreements were entered into on November 15, 2017, with an effective interest rate of 4.31% per annum, payable monthly in arrears. The total long-term obligations under the four agreements amounted to RMB 235,000,000 (approximately $35,964,617), pledged by the Company’s equipment in the original cost of RMB 238,333,639 (approximately $36,474,800). Total proceeds under these loan agreements, net of deposits on loan agreements of $5,196,271 which was deducted by COSCO, totaled $29,692,975, including cash of RMB 100,000,000 or $14,846,487 and bank acceptance notes in the amount of RMB 100,000,000 or $14,846,488. For the year ended December 31, 2017, repayment of principal for these loan agreements was in the amount of $1,408,826. The Company also paid debt issuance costs in cash in the amount of $1,025,248 for the year ended December 31, 2017.

 

The interest expense for long term loans was in the amount of $347,817 for the year ended December 31, 2017.

 

The following table summarizes the aggregate required repayments of principal amounts of the Company’s long term loans in the succeeding five years and thereafter:

 

   Amount 
For the years ending December 31,     
2018  $24,266,031 
2019   21,638,468 
2020   15,744,756 
Thereafter    
      
Total  $61,649,255 

 

NOTE 14 – RESERVE

 

The reserve funds were comprised of the following:

 

   December 31, 2017   December 31, 2016 
Statutory surplus reserve fund  $17,562,357   $15,129,935 
Total  $17,562,357   $15,129,935 

 

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

 

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

 

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

 

 55 

 

 

NOTE 15 - 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 provided for a reduced tax rate of 15% for years 2009 through 2011. The Company used a tax rate of 25% for the first three quarters of 2012. In December 2012, the Joint Venture passed the re-assessment of “High-Tech Enterprise” designation by the government, according to relevant PRC income tax laws. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate for years 2012 through 2014. In 2015, the Joint Venture was awarded the Chinese government's "High-Tech Enterprise" designation for a third time, which is valid for three years and it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017.

 

The reconciliation of the effective income tax rate of the Joint Venture to the statutory income tax rate in the PRC for the years ended December 31, 2017 and 2016 is as follows:

 

   Years Ended December 31, 
   2017   2016 
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%
China statutory income tax rate   25.00%   25.00%
Effects of income tax exemptions and reliefs   -10.00%   -10.00%
Effects of additional deduction allowed for R&D expenses   -2.34%   -2.88%
Effects of expenses not deductible for tax purposes   0.79%   0.61%
Other items   1.41%   0.54%
Effective tax rate   14.86%   13.27%

 

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 or burden recorded for the entity located in U.S. The tax authority may examine the tax returns of the Company three years after the year ended. The provisions for income taxes for the years ended December 31, 2017 and 2016, respectively, are summarized as follows:

 

 56 

 

 

   December 31, 2017   December 31, 2016 
         
Current  $5,524,868   $3,769,316 
Deferred   (807,058)   (502,903)
           
Total  $4,717,810   $3,266,413 

 

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 December 31, 2017 and 2016.

 

NOTE 16 – NON-CONTROLLING INTEREST IN SUBSIDIARIES

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest, owned by Ruili Group Co., Ltd., in Ruian.

 

Net income attributable to non-controlling interest in subsidiaries amounted to $2,702,691 and $2,135,516 for the years ended December 31, 2017 and 2016, respectively.

 

   2017   2016 
10% non-controlling interest in Ruian  $2,702,691   $2,135,516 
           
Total  $2,702,691   $2,135,516 

 

NOTE 17 – 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 initial lease term was 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 $311,776).

 

In May 2009, Ruian entered into a lease agreement with Ruili Group for the lease of a manufacturing plant. The lease was from September 2009 to May 2017. In August 2010, a new lease agreement was signed between Ruian and Ruili Group, under which Ruian leased 89,229 square meters manufacturing plant for its new purchased passenger vehicles brake systems business. The lease term was from September 2009 to August 2020. This lease was amended in 2013. The amended lease term was from January 1, 2013 to December 31, 2017. The annual lease expense was RMB 8,137,680 (approximately $1,293,070). The lease was terminated in May 2016 when the Developed Zone Facility was purchased by the Company. Also see Note 7 for more details.

 

The lease expenses were $311,776 and $716,656 for the years ended December 31, 2017 and 2016, respectively. As of December 31, 2017, future minimum rental payments are as follows:

 

   2018  2019  2020  2021  2022  Thereafter
                               
Operating Lease Commitments  $321,386   $321,386   $321,386   $321,386   $321,386   $—   

 

 57 

 

 

NOTE 18 – WARRANTY CLAIMS

 

Warranty claims were $1,570,290 and $2,503,950 for the years ended December 31, 2017 and 2016, respectively. Warranty claims are classified as accrued expenses on the consolidated balance sheets. The movement of accrued warranty expenses for the year ended December 31, 2017 is as follows:

 

Beginning balance at January 1, 2017  $6,517,402 
Aggregate increase for new warranties issued during current period   1,570,290 
Aggregate reduction for payments made and effect of exchange rate fluctuation   (1,510,797)
Ending balance at December 31, 2017  $6,576,895 

 

NOTE 19 – 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. The Company and its subsidiaries do not have long-lived assets in the United States for the reporting periods.

 

   2017   2016 
         
NET SALES TO EXTERNAL CUSTOMERS          
Commercial vehicles brake systems  $330,201,227   $224,213,063 
Passenger vehicles brake systems   60,321,342    54,530,059 
           
Net sales  $390,522,569   $278,743,122 
INTERSEGMENT SALES          
Commercial vehicles brake systems  $   $ 
Passenger vehicles brake systems        
           
Intersegment sales  $   $ 
GROSS PROFIT          
Commercial vehicles brake systems  $89,355,410   $63,051,542 
Passenger vehicles brake systems   14,830,792    12,338,494 
Gross profit  $104,186,202   $75,390,036 
Selling and distribution expenses   39,067,566    29,837,757 
General and administrative expenses   22,023,338    15,206,423 
Research and development expenses   11,004,560    7,709,533 
           
Other operating income, net   3,039,824    555,946 
           
Income from operations   35,130,562    23,192,269 
           
Interest income   232,466    1,047,667 
Government grants   2,264,055    832,264 
Other income   101,475    1,244,078 
Interest expenses   (3,100,396)   (887,097)
Other expenses   (2,883,440)   (807,858)
Income before income tax expense  $31,744,722   $24,621,323 
CAPITAL EXPENDITURE          
Commercial vehicles brake systems  $44,185,254   $13,078,806 
Passenger vehicles brake systems   8,074,065    2,810,887 
           
Total  $52,259,319   $15,889,693 
DEPRECIATION AND AMORTIZATION          
Commercial vehicles brake systems  $7,828,921   $5,959,168 
Passenger vehicles brake systems   1,430,595    1,280,740 
           
Total  $9,259,516   $7,239,908 

  

   December 31, 2017   December 31, 2016 
     
TOTAL ASSETS          
Commercial vehicles brake systems  $492,348,129   $248,023,179 
Passenger vehicles brake systems   89,967,813    53,304,945 
           
Total  $582,315,942   $301,328,124 

 

   December 31, 2017   December 31, 2016 
     
LONG LIVED ASSETS          
Commercial vehicles brake systems  $106,779,681   $53,520,623 
Passenger vehicles brake systems   19,512,076    11,748,429 
           
Total  $126,291,757   $65,269,052 

  

NOTE 20 – COMMITMENTS AND CONTINGENCIES

 

(1) As described in Note 7, the Company purchased the Dongshan Facility from Ruili Group in 2007 and subsequently transferred the plants and land use right to Ruili Group. The Company has never obtained the land use rights certificate nor the property ownership certificate of the building for the Dongshan Facility. 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 Dongshan Facility in the transaction, which the Company considered as the most probable amount of tax liability. The Dongshan Facility was transferred back to Ruili Group on May 5, 2016.

 

(2) As described in Note 7, the Company purchased the Development Zone Facility from Ruili Group on May 5, 2016. As of the filing date, the Company hasn’t obtained the land use rights certificate or the property ownership certificate for the building of the Development Zone Facility. The Company reserved the relevant tax amount of RMB 15,030,000 (approximately $2,300,205). This amount was determined based on a 3% tax rate on the consideration paid for the Development Zone Facility, which the Company considered as the most probable amount of tax liability.

 

(3) The information of lease commitments is provided in Note 17.

 

(4) The information of guarantees and assets pledged is provided in Note 4.

 

 58 

 

 

NOTE 21 – SUBSEQUENT EVENTS

 

During the subsequent period, the Company obtained short term loans in the total amount of approximately $126,041,000 from Bank of China, Agricultural Bank of China, China Minsheng Bank, China Zheshang Bank, Huaxia Bank and Industrial and Commercial Bank of China. Interest rates for those loans ranged from 3.00% to 5.72% per annum. The maturity dates of the loans existing as of the filing date ranged from January 30, 2018 to March 15, 2019. As of the filing date, the Company pledged accounts receivable of approximately $3,731,000, as collateral under the loan arrangements with Bank of China. The Company continuously pledged bank acceptance notes to obtain loans from Agricultural Bank of China.

 

In the same period, the Company repaid loan principals and interest expenses in the total amount of approximately $68,525,000 to Bank of China, China Construction Bank, China Zheshang Bank, and Agricultural Bank of China.

 

During the subsequent period, the Company continued to provide loans to Shanghai Ruili and Kunshan Yuetu, two related parties under common control, in the amounts of RMB 332,000,000 (approximately $50,810,000) and RMB 97,000,000 (approximately $14,845,000), respectively, with an interest rate of 5.22% per annum payable quarterly in arrears.

 

ADDITIONAL INFORMATION─FINANCIAL STATEMENT SCHEDULE I

 

This financial statements schedule has been prepared in conformity with U.S. GAAP.

 

SORL AUTO PARTS, INC.

 

This financial statements schedule has been prepared in conformity with U.S. GAAP. The parent company financial statements have been prepared using the same accounting principles and policies described in the notes to the consolidated financial statements, with the only exception being that the Company accounts for its subsidiaries using the equity method. Please refer to the notes to the consolidated financial statements presented above for additional information and disclosures with respect to these financial statements.

 

 59 

 

 

Financial Information of Parent Company

BALANCE SHEETS

December 31, 2017 and 2016

 

   December 31, 2017   December 31, 2016 
         
ASSETS          
Current Assets:          
Other current assets  $86,828   $86,828 
Total Current Assets   -    86,828 
           
Investments in subsidiaries   160,185,796    135,861,575 
           
TOTAL ASSETS  $160,272,624   $135,948,403 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
Current Liabilities:          
Other current liabilities  $2,921,411   $2,921,411 
Total Current Liabilities   2,921,411    2,921,411 
Total Liabilities   2,921,411    2,921,411 
           
Stockholders' Equity:          
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of December 31, 2017 and 2016   -    - 
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of December 31, 2017 and 2016   38,609    38,609 
Additional paid-in capital   (28,582,654)   (28,582,654)
Retained earnings   185,895,258    161,571,037 
Total Stockholders' Equity   157,351,213    133,026,992 
           
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $160,272,624   $135,948,403 

 

 60 

 

 

Financial Information of Parent Company

STATEMENTS OF INCOME

For the Years Ended December 31, 2017 and 2016

 

   For Years Ended December 31, 
   2017   2016 
         
Investment income  $24,324,221   $19,219,637 
Financial expenses   -    243 
Net income attributable to stockholders  $24,324,221   $19,219,394 
           
Weighted average common share - Basic   19,304,921    19,304,921 
           
Weighted average common share - Diluted   19,304,921    19,304,921 
           
EPS - Basic  $1.26   $1.00 
           
EPS - Diluted  $1.26   $1.00 

 

 61 

 

 

Financial Information of Parent Company

STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2017 and 2016

 

   For Years Ended December 31, 
   2017   2016 
         
Cash flow from operating activities:          
Net income  $24,324,221   $19,219,394 
Adjustments to reconcile net income to net cash used in operating activities :          
Investment in subsidiaries   (24,324,221)   (19,219,394)
Other current liabilities   -    (80,667)
Net cash used in operating activities   -    (80,910)
           
Net change in cash and cash equivalents   -    (80,910)
Cash and cash equivalents, beginning of the year   -    80,910 
Cash and cash equivalents, end of the year  $-   $- 

 

 62 

 

 

Financial Information of Parent Company

STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For the Years Ended December 31, 2017 and 2016

 

           Additional         
   Number   Common   Paid-in   Retained   Shareholders' 
   of Share   Stock   Capital   Earnings   Equity 
Balance - December 31, 2015   19,304,921   $38,609   $42,199,014   $142,351,643   $184,589,266 
                          
Net income   -    -    -    19,219,394    19,219,394 
                          
Distribution to controlling shareholders in connection with plant and land use rights exchange with entity under common control   -    -    (70,781,668)   -    (70,781,668)
                          
Balance - December 31, 2016   19,304,921   $38,609   $(28,582,654)  $161,571,037   $133,026,992 
                          
Net income   -    -    -    24,324,221    24,324,221 
                          
Balance – December 31, 2017   19,304,921   $38,609   $(28,582,654)  $185,895,258   $157,351,213 

 

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

(a) 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 December 31, 2017 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 December 31, 2017, were effective, in all material respects, for the purpose stated above.

 

(b) Management’s Report on Internal Control over Financial Reporting

 

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such item is defined in Exchange Act Rules 13a-15(f) and 15d-15(f).

 

Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Because of its inherent limitations, internal control is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected. In evaluating the Company’s internal control over financial reporting, management has adopted the framework in Internal Control-Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission, or the Original Framework. Under the supervision, and with the participation of our management, including CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting, as of December 31, 2017. Based on our evaluation under the framework in the Original Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2017.

 

(c) Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting that occurred during the fourth fiscal quarter of the year covered by this Annual Report on Form 10-K that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 64 

 

 

ITEM 9B. OTHER INFORMATION

 

None.

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The information required by this Item is incorporated by reference to our definitive proxy statement for our 2017 annual meeting of shareholders, which is expected to be filed with the SEC within 120 days after December 31, 2017, and is incorporated herein by reference.

 

ITEM 11. EXECUTIVE COMPENSATION

 

The information required by this Item is incorporated by reference to our definitive proxy statement for our 2017 annual meeting of shareholders, which is expected to be filed with the SEC within 120 days after December 31, 2017, and is incorporated herein by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information required by this Item is incorporated by reference to our definitive proxy statement for our 2017 annual meeting of shareholders, which is expected to be filed with the SEC within 120 days after December 31, 2017, and is incorporated herein by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information required by this Item is incorporated by reference to our definitive proxy statement for our 2017 annual meeting of shareholders, which is expected to be filed with the SEC within 120 days after December 31, 2017, and is incorporated herein by reference.

 

 65 

 

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

 

The information required by this Item is incorporated by reference to our definitive proxy statement for our 2017 annual meeting of shareholders, which is expected to be filed with the SEC within 120 days after December 31, 2017, and is incorporated herein by reference.

 

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

3.List of Exhibits. The following documents are filed as part of this Annual Report:

 

(a)(1) Consolidated Financial Statements:

 

The index of the consolidated financial statements contained herein is set forth on page F-1 hereof. See Item 8 for the financial statements filed with this report.

 

(2)Financial Statement Schedules:

 

The financial statement schedule listed in the index to consolidated financial statements on Page F-1 hereof.

 

All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are not applicable and therefore have been omitted.

 

(3)Exhibits:

 

The exhibits listed on the Exhibit Index (following the signatures section of this report) are included, or incorporated by reference, in this Annual Report.

 

(b)Exhibits:

 

See Item 15(a) (3) above.

 

(c)Financial Statement Schedules:

 

See Item 15(a) (2) above.

 

 66 

 

 

EXHIBIT INDEX

 

EXHIBIT
NO.
  DOCUMENT DESCRIPTION
3.1   Amended and Restated Certificate of Incorporation (1)
     
3.2   Amended and Restated Bylaws (2)
     
10.1   Share Exchange Agreement and Plan of Reorganization (3)
     
10.2   Joint Venture Agreement (revised)(4)
     
10.3   Employment Agreement—Xiao Ping Zhang (5)
     
10.4   Employment Agreement—Xiao Feng Zhang (5)
     
10.5   Employment Agreement—Zong Yun Zhou (5)
     
10.6   Employment Agreement—Jin Rui Yu (6) 
     
31.1   Certification of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
     
31.2   Certification of Principal Financial Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
     
32   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Chief Financial Officer). (7)
     
EX-101.INS   XBRL INSTANCE DOCUMENT
     
EX-101.SCH   XBRL TAXONOMY EXTENSION SCHEMA
     
EX-101.CAL   XBRL TAXONOMY EXTENSION CALCULATION LINKBASE
     
EX-101.DEF   XBRL TAXONOMY EXTENSION DEFINITION LINKBASE
     
EX-101.LAB   XBRL TAXONOMY EXTENSION LABEL LINKBASE
     
EX-101.PRE   XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE

 

 

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

 

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

 

(3)Incorporated herein by reference from Registrant’s Current Report on Form 8-K, and amendment thereto, as filed with the Securities and Exchange Commission on May 24, 2004.

 

(4)Incorporated by reference to Exhibit 10.2 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the Securities and Exchange Commission on March 27, 2008.

 

(5)Incorporated herein by reference from the Registrant’s Form S-1 as filed with the Securities and Exchange Commission on August 31, 2006.

 

(6)Incorporated herein by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on March 7, 2012.

 

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

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 2nd day of April 2018.

 

  SORL AUTO PARTS, INC.
     
  By: /s/ Xiao Ping Zhang
    Xiao Ping Zhang
   

Chief Executive Officer

(Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the Registrant and in the capacities.

 

Name   Position   Date
         
/s/ Xiao Ping Zhang   Chief Executive Officer and Chairman (Principal Executive Officer)   April 2, 2018
Xiao Ping Zhang        
         
/s/ Zong Yun Zhou   Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)   April 2, 2018
Zong Yun Zhou        
         
/s/ Jin Rui Yu   Chief Operating Officer   April 2, 2018
Jin Rui Yu        
         
/s/ Xiao Feng Zhang   Director   April 2, 2018
Xiao Feng Zhang        
         
/s/ Yu Hong Li   Director   April 2, 2018
Yu Hong Li        
         
/s/ Hui Lin Wang   Director   April 2, 2018
Hui Lin Wang        
         
/s/ Jin Bao Liu   Director   April 2, 2018
Jin Bao Liu        
         
/s/ Jiang Hua Feng   Director   April 2, 2018
Jiang Hua Feng        
         
/s/ Shu Ping Chi   Director   April 2, 2018
Shu Ping Chi        

 

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