UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended September 30, 2013

 

¨

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

For the transition period from _________ to _________

 

Commission file number 000-11991

 

SORL AUTO PARTS, INC.

(Exact name of registrant as specified in its charter)

 

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

No. 1169 Yumeng Road

Ruian Economic Development District

Ruian City, Zhejiang Province

People’s Republic Of China

(Address of principal executive offices)

86-577-6581-7720

(Registrant’s telephone number)

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

Yes x No ¨

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

Yes x No ¨

 

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

Large Accelerated Filer ¨

Accelerated Filer ¨

Non-Accelerated Filer ¨

Smaller Reporting Company x

 

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

Yes ¨ No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

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

As of November 14, 2013 there were 19,304,921 shares of Common Stock outstanding

 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Quarter Ended September 30, 2013

 

INDEX

 

		Page
PART I.	FINANCIAL INFORMATION (Unaudited)
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets as of September 30, 2013 (Unaudited) and December 31, 2012	1
	Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 2013 and 2012	2
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2013 and 2012	4
	Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) for the Nine Months Ended September 30, 2013	3
	Notes to the Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis or Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	25
PART II.	OTHER INFORMATION	25
Item 1.	Legal Proceedings.	25
Item 1A.	Risk Factors.	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	25
Item 3.	Defaults Upon Senior Securities.	25
Item 4.	Mine Safety Disclosures.	25
Item 5.	Other Information.	25
Item 6.	Exhibits	25
SIGNATURES		26

 

 

SORL Auto Parts, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

		September 30, 2013				December 31, 2012
		(Unaudited)
Assets
Current Assets
Cash and cash equivalents		US$	32,520,391			US$	41,253,353
Accounts receivable, net of provision, including $453,709 and $0 due from related parties at September 30, 2013 and December 31, 2012, respectively.			54,840,095				62,153,509
Bank acceptance notes from customers			22,646,328				10,098,390
Inventories			70,976,416				56,775,825
Prepayments			6,176,942				5,722,743
Current portion of prepaid capital lease interest			508,745				876,326
Other current assets			3,029,184				1,183,487
Deferred tax assets			1,001,555				687,632
Total Current Assets			191,699,656				178,751,265
Fixed Assets
Property, plant and equipment, net			46,351,853				46,962,599
Leasehold improvements in progress			278,838				335,714
Land Use Rights, Net			14,825,863				14,742,047
Other Non-Current Assets
Intangible assets, net			55,685				66,889
Security deposits on lease agreement			1,858,909				1,879,831
Long term deferred expense-prepaid interest			478,372				822,640
Total Other Non-Current Assets			2,392,966				2,769,360
Total Assets		US$	255,549,176			US$	243,560,985
Liabilities and Shareholders' Equity
Current Liabilities
Accounts payable, including $722,787 and $94,954 due to related parties at September 30, 2013 and December 31, 2012, respectively.		US$	8,952,443			US$	14,324,633
Deposit received from customers			14,129,926				6,599,746
Short term bank loans			6,033,111				14,599,753
Accrued expenses			10,888,980				8,501,819
Current portion of capital lease obligations			3,717,818				10,458,352
Other current liabilities, including $82,670 and $33,083 due to related parties at September 30, 2013 and December 31, 2012, respectively.			160,278				313,006
Total Current Liabilities			43,882,556				54,797,309
Non-Current Liabilities
Non-current portion of capital lease obligations			8,365,089				-
Deferred tax liabilities			342,019				291,995
Total Non-Current Liabilities			8,707,108				291,995
Total Liabilities			52,589,664				55,089,304
Stockholders' Equity
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of September 30, 2013 and December 31, 2012			-				-
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of September 30, 2013 and December 31, 2012			38,609				38,609
Additional paid-in capital			42,199,014				42,199,014
Reserves			10,523,452				9,676,183
Accumulated other comprehensive income			26,364,789				22,020,008
Retained earnings			103,845,929				96,114,407
Total SORL Auto Parts, Inc. Stockholders' Equity			182,971,793				170,048,221
Noncontrolling Interest In Subsidiaries			19,987,719				18,423,460
Total Equity			202,959,512				188,471,681
Total Liabilities and Stockholders' Equity		US$	255,549,176			US$	243,560,985

 

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

 

 

SORL Auto Parts, Inc. and Subsidiaries

Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Sales		US$	54,488,640			US$	46,708,959			US$	153,317,804			US$	143,399,372
Include: sales to related parties			825,101				1,092,343				2,067,673				5,046,533
Cost of sales			39,969,212				33,485,059				111,332,963				103,779,982
Gross profit			14,519,428				13,223,900				41,984,841				39,619,390
Expenses:
Selling and distribution expenses			4,383,239				3,765,768				12,122,573				10,460,168
General and administrative expenses			3,696,715				2,630,786				13,079,992				9,981,552
Research and development expenses			2,384,902				2,352,958				5,392,513				5,916,934
Total operating expenses			10,464,856				8,749,512				30,595,078				26,358,654
Income from operations			4,054,572				4,474,388				11,389,763				13,260,736
Other income			858,653				1,207,961				1,723,767				1,972,781
Financial expenses			(770,418	)			(541,326	)			(2,208,756	)			(1,668,945	)
Non-operating expenses			(77,073	)			(112,927	)			(210,243	)			(366,119	)
Net income before provision for income taxes			4,065,734				5,028,096				10,694,531				13,198,453
Provision for income taxes			332,027				1,180,601				1,040,215				3,479,019
Net income		US$	3,733,707			US$	3,847,495			US$	9,654,316			US$	9,719,434
Less: Net income attributable to noncontrolling interest in subsidiaries			423,087				486,581				1,075,525				1,028,504
Net income attributable to common stockholders		US$	3,310,620			US$	3,360,914			US$	8,578,791			US$	8,690,930
Comprehensive income
Net income		US$	3,733,707			US$	3,847,495			US$	9,654,316			US$	9,719,434
Foreign currency translation adjustments			1,023,444				(460,819	)			4,833,515				(1,068,653	)
Comprehensive income			4,757,151				3,386,676				14,487,831				8,650,781
Comprehensive income attributable to noncontrolling interest in subsidiaries			532,333				440,610				1,564,259				926,282
Comprehensive income attributable to common shareholders		US$	4,224,818			US$	2,946,066			US$	12,923,572			US$	7,724,499
Weighted average common share - basic			19,304,921				19,304,921				19,304,921				19,304,921
Weighted average common share - diluted			19,304,921				19,304,921				19,304,921				19,304,921
EPS - basic		US$	0.17			US$	0.17			US$	0.44			US$	0.45
EPS - diluted		US$	0.17			US$	0.17			US$	0.44			US$	0.45

 

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

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders' Equity (Unaudited)

 

For The Nine Months Ended on September 30, 2013

 

										Additional								Retained				Accumu. Other
		Number				Common				Paid-In								Earnings				Comprehensive				Shareholders'				Noncontrolling				Total
		of Share				Stock				Capital				Reserves				(Deficit)				Income				Equity				Interest				Equity
Beginning Balance - January 1, 2013			19,304,921			$	38,609			$	42,199,014			$	9,676,183			$	96,114,407			$	22,020,008			$	170,048,221			$	18,423,460			$	188,471,681
Net income			-				-				-				-				8,578,791				-				8,578,791				1,075,525				9,654,316
Foreign currency translation adjustment			-				-				-				-				-				4,344,781				4,344,781				488,734				4,833,515
Transfer to reserve			-				-				-				847,269				(847,269	)			-				-				-				-
Ending Balance -September 30, 2013			19,304,921			$	38,609			$	42,199,014			$	10,523,452			$	103,845,929			$	26,364,789			$	182,971,793			$	19,987,719			$	202,959,512

 

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

 

 

SORL Auto Parts, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

		Nine Months Ended September 30,
		2013				2012
Cash Flows From Operating Activities
Net income		US$	9,654,316			US$	9,719,434
Adjustments to reconcile net income to net cash from operating activities:
Bad debt expense			1,371,727				(143,830	)
Depreciation and amortization			5,960,145				5,602,370
Deferred income taxes			(252,018	)			(96,446	)
Loss on disposal of fixed assets			5,196				10,359
Changes In Assets and Liabilities:
Accounts receivable			8,037,713				3,102,469
Bank acceptance notes from customers			(12,252,121	)			5,587,439
Other currents assets			(1,756,558	)			2,491,925
Inventories			(12,687,012	)			172,988
Prepayments			(319,823	)			(4,112,124	)
Accounts payable and bank acceptance notes to vendors			(6,259,596	)			(6,544,574	)
Income tax payable			-				866,586
Deposits received from customers			7,317,768				487,330
Other current liabilities and accrued expenses			2,248,257				373,621
Net Cash Flows Provided By Operating Activities			1,067,994				17,517,547
Cash Flows From Investing Activities
Acquisition of property and equipment			(3,356,852	)			(941,286	)
Proceeds of disposal of fixed assets			14,602				6,886
Leasehold improvements in progress			-				(31,069	)
Net Cash Flows Used In Investing Activities			(3,342,250	)			(965,469	)
Cash Flows From Financing Activities
Proceeds from bank loans			60,307,996				23,152,945
Repayment of bank loans			(69,079,151	)			(27,263,968	)
Proceeds from capital lease			12,783,841				-
Repayment of capital lease			(11,400,163	)			(1,708,171	)
Net Cash Flows Used In Financing Activities			(7,387,477	)			(5,819,194	)
Effects on changes in foreign exchange rate			928,771				44,756
Net change in cash and cash equivalents			(8,732,962	)			10,777,640
Cash and cash equivalents- beginning of the year			41,253,353				17,116,692
Cash and cash equivalents - end of the period		US$	32,520,391			US$	27,894,332
Supplemental Cash Flow Disclosures:
Interest paid		US$	1,247,619			US$	1,929,388
Tax paid		US$	1,772,230			US$	4,765,828

 

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

 

 

SORL Auto Parts, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

 

NOTE A - DESCRIPTION OF BUSINESS

 

SORL Auto Parts, Inc. (together with its subsidiaries, “we,” “us,” “our” or the “Company” or “SORL”) is principally engaged in the manufacture and distribution of vehicle brake systems and other key safety-related components, through its 90% ownership of Ruili Group Ruian Auto Parts Co., Ltd. (the “Joint Venture”) and 60% ownership of SORL International Holding, Ltd. ("SIH") in Hong Kong. The Company distributes products both in China and internationally under SORL trademarks. The Company’s product range includes 65 categories and over 2000 different specifications.

 

On November 11, 2009, the Company entered into a joint venture agreement with MGR, a Hong Kong-based global auto parts distribution specialist firm and a Taiwanese investor. The new joint venture was named SIH. SORL holds a 60% interest in the joint venture, MGR holds a 30% interest, and the Taiwanese investor holds a 10% interest. SIH is primarily devoted to expanding SORL's international sales network in Asia-Pacific and creating a larger footprint in Europe, the Middle East and Africa with a target to create a truly global distribution network. Based in Hong Kong, SIH is expanding and establishing channels of distribution in international markets with SORL's primary products, including spring brake chambers, clutch servos, air dryers, relay valves and hand brake valves.

 

On February 8, 2010, the Company sold 1,000,000 shares of its common stock to selected institutional investors at a price of $10.00 per share pursuant to a registered direct offering. This transaction provided net proceeds of approximately $9.4 million. On March 9, 2010, through Fairford Holdings Limited (“Fairford”), a wholly owned subsidiary of the Company, SORL invested $9.349 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 USD$1.039 million. Accordingly, SORL continues to hold a 90% controlling interest in the operating subsidiary.

 

On August 31, 2010, the Company, through the Joint Venture, executed an agreement to acquire the assets of the hydraulic brake, power steering, and automotive electrical operations of the Ruili Group ( a related party under common control). As a result of this acquisition, the Company's product offerings expanded to both commercial and passenger vehicles' brake systems and other key safety-related auto parts. The purchase price was RMB 170 million, or approximately USD$25 million. The transaction was accounted for using the book value of assets acquired, consisting primarily of machinery and equipment, inventory, accounts receivable and patent rights, used or usable in connection with the acquired segment of the auto parts business of the Seller. The Company purchased the machinery and equipment, inventory, accounts receivable at book values of $8.0 million, $8.0 million and $5.2 million, respectively. The Company did not acquire any of the assets of the Seller other than those in the segment of Seller's business described above. The excess of consideration over the carrying value of net assets received has been recorded as a decrease in the additional paid-in capital of the Company.

 

The acquisition was accounted for as a transaction between the entities under common control because the CEO of the Company owns 63% of the registered capital of Ruili Group, and owns more than 50% of the outstanding common stock of SORL, together with his wife and brother. This results in the acquisition being accounted for using the historical costs of the financial statements of the Seller. The consolidated financial statements have been prepared as if the acquisition took place at the earliest time presented, that is, as of January 1, 2009. The assets purchase was deemed to be the acquisition of a business.

 

 

NOTE B - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

(1)

BASIS OF PRESENTATION

 

The condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All intercompany balances and transactions have been eliminated in the consolidation. Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted as permitted by the rules and regulations of the United States Securities and Exchange Commission, although the Company believes that the disclosures contained in this report are adequate to make the information presented not misleading. The condensed consolidated balance sheet information as of December 31, 2012 was derived from the audited consolidated financial statements included in Form 10-K. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2012, and other reports filed with the SEC.

 

The accompanying condensed unaudited interim consolidated financial statements reflect all adjustments of a normal and recurring nature which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. The results of operations for these periods are not necessarily comparable to, or indicative of, results of any other interim period or for the fiscal year taken as a whole.

 

(2)

SIGNIFICANT ACCOUNTING POLICIES

 

a. ACCOUNTING METHOD

 

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

 

b. USE OF ESTIMATES

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities on 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 during the period when new information becomes available to the management. Actual results could differ from those estimates.

 

c. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

For certain of the Company’s financial instruments, including cash and cash equivalents, trade receivables and payables, prepaid expenses, deposits and other current assets, short-term bank borrowings, and other payables and accruals, the carrying amounts approximate fair values due to their short maturities.

 

d. REVENUE RECOGNITION

 

Revenue from the sale of goods is recognized when the risks and rewards of ownership of the goods have transferred to the buyer including factors such as when persuasive evidence of an arrangement exsits, 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.

 

e. FOREIGN CURRENCY TRANSLATION

 

The Company maintains its books and accounting records in Renminbi (“RMB”), the currency of the PRC. The Company’s functional currency is also RMB. The Company has adopted FASB ASC 830-30 in converting financial statement amounts from RMB to the Company’s reporting currency, United States dollars (“US$”). All assets and liabilities are converted at the current rate. The shareholders’ equity accounts are converted at appropriate historical rate. Revenue and expenses are converted at the weighted average rates in effect on the transaction dates.

 

 

Conversion 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.

 

f. RECLASSIFICATIONS

 

Certain items previously reported under specific financial statement captions have been reclassified to conform to the current year presentation.

 

NOTE C- RECENTLY ISSUED FINANCIAL STANDARDS

 

In February 2013, the FASB issued ASU 2013-02, “Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). Under ASU 2013-02, an entity is required to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in the financial statements. The amendments in this update will be effective for fiscal years and interim periods within those years beginning after December 15, 2012. The Company adopted this pronouncement effective January 1, 2013 and the adoption did not have a material impact on the Company’s consolidated financial statements.

 

In March 2013, the FASB issued ASU 2013-05, “Foreign Currency Matters (Topic 830)—Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity”. These amendments provide guidance on releasing Cumulative Translation Adjustments when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. In addition, these amendments provide guidance on the release of CTA in partial sales of equity method investments and in step acquisitions. For public entities, the amendments are effective on a prospective basis for fiscal years and interim reporting periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to derecognition events occurring after the effective date. Prior periods should not be adjusted. The Company does not expect the adoption to have a significant impact on its consolidated financial statements.

 

In July 2013, the FASB issued ASU 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”. These amendments provide that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-11 is not expected to have a material impact on the Company’s consolidated financial statements.

 

 

NOTE D - RELATED PARTY TRANSACTIONS

 

The Company continued to purchase packaging materials from the Ruili Group Co., Ltd. The Ruili Group Co., Ltd. is the minority shareholder of Joint Venture and is controlled by the Zhang family, who is also the controlling party of the Company. The Company sold certain automotive products to Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd., which is controlled by the Ruili Group Co., Ltd. MGR holds a 30% interest in SIH. The stockholders of MGR were the management of SIH.

 

The following related party transactions are reported for the three months and nine months ended September 30, 2013 and September 30, 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
PURCHASES FROM:
Ruian Kormee Vehicle brake  Co., Ltd.		$	692,079			$	—			$	1,508,268			$	—
Guangzhou Kormee Vehicle brake technology development Co., Ltd.			—				—				551,457				—
Ruili Group Co., Ltd.			1,302,818				1,610,289				3,349,422				4,193,135
Total Purchases		$	1,994,897			$	1,610,289			$	5,409,147			$	4,193,135
SALES TO:
Guangzhou Kormee Vehicle brake technology development Co., Ltd.		$	307,816			$	650,405			$	597,387			$	3,145,984
Ruian Kormee Vehicle brake  Co., Ltd.			22,135				—				22,135				—
Ruili Group Co., Ltd.			495,150				441,938				1,448,151				1,900,549
Total Sales		$	825,101			$	1,092,343			$	2,067,673			$	5,046,533

 

		September 30,				December 31,
		2013				2012
ACCOUNTS RECEIVABLES
Guangzhou Kormee Vehicle brake technology development Co., Ltd.		$	453,709			$	—
Total		$	453,709			$	—
ACCOUNTS PAYABLE
Ruian Kormee Vehicle brake Co., Ltd.		$	31,916			$	—
Ruili Group Co., Ltd.			690,871				94,954
Total		$	722,787			$	94,954
OTHER PAYABLES
MGR Hong Kong Limited		$	82,670			$	25,559
Ruili Group Co., Ltd.			—				7,524
Total		$	82,670			$	33,083

 

 

NOTE E - ACCOUNTS RECEIVABLE

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the quarter ended September 30, 2013. The changes in the allowance for doubtful accounts at September 30, 2013 and December 31, 2012 are summarized as follows:

 

		September 30, 2013				December 31, 2012
Beginning balance		$	998,492			$	892,455
Add: Increase to allowance			1,464,685				106,037
Less: Accounts written off			—				—
Ending balance		$	2,463,177			$	998,492

 

		September 30,				December 31,
		2013				2012
Accounts receivable		$	57,303,272			$	63,152,001
Less: allowance for doubtful accounts			(2,463,177	)			(998,492	)
Account receivable balance, net		$	54,840,095			$	62,153,509

 

NOTE F - INVENTORIES

 

At September 30, 2013 and December 31, 2012, inventories consisted of the following:

 

		September 30, 2013				December 31, 2012
Raw materials		$	14,597,854			$	9,116,931
Work in process			16,786,989				20,552,486
Finished goods			39,591,573				27,106,408
Total Inventories		$	70,976,416			$	56,775,825

 

 

NOTE G - PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following, at September 30, 2013 and December 31, 2012:

 

		September 30, 2013				December 31, 2012
Machinery		$	46,149,596			$	52,212,579
Molds			1,419,265				1,384,781
Office equipment			1,988,693				1,637,402
Vehicles			2,072,172				2,025,702
Buildings			9,109,785				8,888,441
Machinery held under capital lease			29,031,949				18,165,511
Sub-Total			89,771,460				84,314,416
Less: Accumulated depreciation			(43,419,607	)			(37,351,817	)
Property, plant and equipment, net		$	46,351,853			$	46,962,599

 

Depreciation expense charged to operations was $5,101,292 and $5,251,641 for the nine months ended September 30, 2013 and September 30, 2012, respectively.

 

NOTE H - DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES

 

Deferred tax assets consisted of the following as of September 30, 2013 and December 31, 2012:

 

		September 30, 2013				December 31, 2012
Deferred tax assets - current
Provision		$	376,548			$	156,673
Warranty			681,638				568,161
Deferred tax assets			1,058,186				724,834
Valuation allowance			―				―
Net deferred tax assets - current			1,058,186				724,834
Deferred tax liabilities - current
Revenue (net off cost)			56,631				37,202
Deferred tax liabilities - current
Net deferred tax assets - current		$	1,001,555			$	687,632
Deferred tax liabilities - non-current
Land use right		$	342,019			$	291,995
Deferred tax liabilities - non-current		$	342,019			$	291,995

 

 

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 the U.S. as the Company had no United States taxable income for the reporting period. The Company’s subsidiary registered in the PRC is subject to income taxes within the PRC at the applicable tax rate.

 

NOTE I – SHORT-TERM BANK LOANS

 

Bank loans represented the following as of September 30, 2013 and December 31, 2012:

 

		September 30,				December 31,
		2013				2012
Secured		$	6,033,111			$	14,599,753

 

The Company obtained those short term loans from Bank of China and Agricultural Bank of China, respectively, to finance general working capital as well as new equipment acquisition. Interest rate for the loans ranged from 2.55% to 2.91% per annum. The maturity dates of the loans ranged from November 15, 2013 to January 22, 2014.

 

As of September 30, 2013, accounts receivable with a total balance of $7,502,170 were pledged as collateral for the bank loan with a balance of $6,001,736. As of December 31, 2012, accounts receivable with an amount of $9,860,742 were pledged as collateral for the bank loan with an amount of $9,846,615. The difference between the accounts receivable pledged and the bank loans obtained was due to the fluctuation of exchange rate as some accounts receivables pledged were denominated in US dollars.

 

Corporate or personal guarantee:

$4.9 Million		Guaranteed by Ruili Group Co., Ltd., a related party;
$1.1 Million		Guaranteed by Ruili Group Co., Ltd., a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both are principal shareholders.

 

NOTE J –CAPITAL LEASE OBLIGATIONS

 

		September 30,				December 31,
		2013				2012
Total Capital Lease Obligations		$	12,082,907			$	10,458,352
Less: Current portion		$	(3,717,818	)		$	(10,458,352	)
Non-current portion		$	8,365,089			$	—

 

 

The 2012 capital lease obligation was under an agreement with International Far Eastern Leasing Co., Ltd., for a term of 60 months and an interest rate of 7.95% per annum, payable monthly in arrears. International Far Eastern Leasing Co., Ltd. is the subsidiary of China Sinochem Corporation. To reduce the financing expense, the Company entered into a new leasing agreement with International Far Eastern Leasing Co., Ltd. in December 2012 and terminated the original agreement. The duration of the new agreement is forty eight (48) months. The value of the leased equipment is RMB 91, 428,571, with a security deposit of RMB 11, 428,571. The actual amount received by the Company is RMB 80, 000,000. The Company prepaid all interests of RMB 10, 705,357 after the discount and is obligated for the lease payment of RMB 1, 904,761.90 monthly. The prepaid capital lease interest is amortized over the life of capital lease agreement using the effective interest method.

 

NOTE K - INCOME TAXES

 

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

 

Company increased its investment in the Joint Venture as a result of its financing conditions in December, 2006. In accordance with the Income Tax Law of the People's Republic of China on Foreign-invested Enterprises and Foreign Enterprises, the Joint Venture is eligible for additional preferential tax treatment. For the years 2007 and 2008, the Joint Venture was entitled to an income tax exemption on all pre-tax income generated by the company above its pre-tax income generated in the year 2006. Thereafter, the Joint Venture would enjoy a 50% exemption from the effective income tax rate on any pre-tax income above its 2006 pre-tax income, to be recognized in the years 2009, 2010 and 2011. The above taxation exemption was superseded, because the Joint Venture had been awarded the Chinese government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate was 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. Accordingly, it continues to be taxed at a 15% rate in 2012 through 2014.

 

The reconciliation of the effective income tax rate of the Company to the statutory income tax rate in the PRC for the nine months ended September 30, 2013 and 2012 is as follows:

 

		Nine months ended September 30, 2013				Nine months ended September 30, 2012
US statutory income tax rate			35.00	%			35.00	%
Valuation allowance recognized with respect to the loss in the US company			-35.00	%			-35.00	%
HK statutory income tax rate			16.50	%			16.50	%
Valuation allowance recognized with respect to the loss in those HK company			-16.50	%			-16.50	%
China statutory income tax rate			25.00	%			25.00	%
China statutory income exemption			-10.00	%			0.00	%
Other items			-5.27	%			1.36	%
Effective tax rate			9.73	%			26.36	%

 

 

		Nine months ended September 30, 2013				Nine months ended September 30, 2012
Computed income tax provision at the statutory rate		$	2,620,551			$	3,263,349
Tax exemption			(1,126,022	)			―
Deferred tax provision			(252,018	)			(96,446	)
Current period permanent differences and other reconciling items			(202,296	)			312,116
Total income taxes		$	1,040,215			$	3,479,019

 

Income taxes are calculated on a separate entity basis. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s net deferred tax assets and liabilities are approximately as mentioned above at September 30, 2013. There is currently no tax benefit recorded for the United States. The tax authority may examine the tax returns of the Company in three years after the year ended. In the nine months ended September 30, 2013, there were no penalties and interest, which generally are recorded in the general and administrative expenses or in the tax expenses. The provisions for income taxes for the nine months ended September 30, 2013 and 2012, respectively, are summarized as follows:

 

		Nine months ended September 30, 2013				Nine months ended September 30, 2012
Current		$	1,292,233			$	3,575,465
Deferred			(252,018	)			(96,446	)
Total		$	1,040,215			$	3,479,019

 

As of September 30, 2013 and December 31, 2012, the Company has no unrecognized tax benefits.

 

NOTE L - NONCONTROLLING INTEREST IN SUBSIDIAIRES

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest, owned by Ruili Group Co., Ltd., in Joint Venture, and a 40% non-controlling interest, owned by the Company’s Joint Venture partners, in SIH. Net income attributable to non-controlling interests in subsidiaries amounted to $1,075,525 and $1,028,504 for the nine months ended September 30, 2013 and 2012, respectively.

 

		September 30, 2013				September 30, 2012
10% non-controlling interest in Ruian		$	941,410			$	957,402
40% non-controlling interest in SIH		$	134,115			$	71,102
Total		$	1,075,525			$	1,028,504

 

 

NOTE M - WARRANTY CLAIMS

 

Warranty claims were $1,589,950 and $1,474,058 for the nine months ended September 30, 2013 and September 30, 2012, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The movement of accrued warranty expenses for the nine months ended September 30, 2013 was as follows:

 

Beginning balance at January 1, 2013		$	3,787,738
Aggregate reduction for payments made			(833,435	)
Aggregate increase for new warranties issued during current period			1,589,950
Effect on changes in foreign exchange rate			―
Ending balance at September 30, 2013		$	4,544,253

 

NOTE N – SEGMENT INFORMATION

 

The Company produces brake systems and other related components (“commercial vehicles brake systems, etc.”) for different types of commercial vehicles. On August 31, 2010, the Company through Joint Venture, executed an Asset Purchase Agreement to acquire, and purchased, a segment of the passenger vehicle auto parts business (passenger vehicles brake systems, etc.) of Ruili Group Co., Ltd. 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 vehicles brake systems and passenger vehicles brake systems.

 

All of the Company’s long-lived assets are located in the PRC and Hong Kong. The Company and its subsidiaries do not have long-lived assets in the United States for the reporting period.

 

 

		Nine Months Ended September 30,
		2013				2012
NET SALES TO EXTERNAL CUSTOMERS
Commercial vehicles brake systems		$	124,244,854			$	111,678,786
Passenger vehicles brake systems			29,072,950				31,720,586
Net sales		$	153,317,804			$	143,399,372
INTERSEGMENT SALES
Commercial vehicles brake systems		$	―			$	―
Passenger vehicles brake systems			―				―
Intersegment sales		$	―			$	―
GROSS PROFIT
Commercial vehicles brake systems		$	33,383,978			$	30,813,735
Passenger vehicles brake systems			8,600,863				8,805,655
Gross profit		$	41,984,841			$	39,619,390
Selling and distribution expenses			12,122,573				10,460,168
General and administrative expenses			13,079,992				9,981,552
Research and development expenses			5,392,513				5,916,934
Income from operations			11,389,763				13,260,736
Financial expenses			(2,208,756	)			(1,668,945	)
Other income (expense), net			1,513,524				1,606,662
Income before income tax expense		$	10,694,531			$	13,198,453
CAPITAL EXPENDITURE
Commercial vehicles brake systems		$	2,730,650			$	742,865
Passenger vehicles brake systems			626,202				198,421
Total		$	3,356,852			$	941,286
DEPRECIATION AND AMORTIZATION
Commercial vehicles brake systems		$	4,848,970			$	4,393,112
Passenger vehicles brake systems			1,111,175				1,209,258
Total		$	5,960,145			$	5,602,370

 

		September 30, 2013				December 31, 2012
TOTAL ASSETS
Commercial vehicles brake systems		$	203,029,911			$	192,842,721
Passenger vehicles brake systems			52,519,265				50,718,264
Total		$	255,549,176			$	243,560,985

 

 

		September 30, 2013				December 31, 2012
LONG LIVED ASSETS
Commercial vehicles brake systems		$	50,727,467			$	50,662,641
Passenger vehicles brake systems			13,122,053				13,324,439
Total		$	63,849,520			$	63,987,080

 

All of the Company’s long-lived assets are located in the PRC and Hong Kong. The Company and its subsidiaries do not have long-lived assets in the United States for the reporting periods.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following is management’s discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying unaudited condensed consolidated financial statements, as well as information relating to the plans of our current management. This quarterly report on Form 10-Q includes forward-looking statements. Any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Generally, the words “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 or 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 anticipated. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to update these forward-looking statements.

 

The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-Q.

 

OVERVIEW

 

The Company manufactures and distributes automotive brake systems and other key safety-related components to automotive original equipment manufacturers, or OEMs, and the related aftermarket both in China and internationally for use primarily in different types of commercial vehicles, such as trucks and buses, and in passenger vehicles. Management believes that it is the largest manufacturer of automotive brake systems in China for commercial vehicles such as trucks and buses.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

For a summary of our accounting policies and estimates, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the Fiscal Year ended December 31, 2012.

 

See Note K to the attached Unaudited Condensed Consolidated Financial Statements for the information regarding changes in taxation by the government of China.

 

 

Results of Operations

 

Results of operations for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012.

 

SALES

 

		Three Months ended								Three Months ended
		September 30, 2013								September 30, 2012
		(U.S.  dollars in millions)
Commercial vehicle brake systems, etc.		$	43.3				79.4	%		$	36.3				77.7	%
Passenger vehicle brake systems, etc.		$	11.2				20.6	%		$	10.4				22.3	%
Total		$	54.5				100.0	%		$	46.7				100.0	%

 

Net sales were $54,488,640 and $46,708,959 for the three months ended September 30, 2013 and 2012, respectively, an increase of $7.8 million or 16.7%.

 

The sales from commercial vehicle brake systems increased by $7.0 million or 19.3%, to $43.3 million for the third quarter of 2013, compared to $36.3 million for the same period of 2012. Due to increased sales in the commercial vehicle market in the third quarter of 2013, the sales from the OEM market increased, which increased the sales of commercial vehicle brake systems.

 

The sales from passenger vehicle brake systems increased by $0.8 million or 7.7%, to $11.2 million for the third quarter of 2013, compared to $10.4 million for the same period of 2012.

 

A breakdown of net sales revenue for these markets for the third quarter of the 2013 and 2012 fiscal years, respectively, is set forth below:

 

		Three Months ended September 30, 2013				Percent of Total Sales				Three Months ended September 30, 2012				Percent of Total Sales				Percentage Change
		(U.S. dollars in millions)
China OEM market		$	22.3				40.8	%		$	18.7				40.1	%			18.9	%
China Aftermarket		$	13.1				24.1	%		$	12.2				26.1	%			7.6	%
International market		$	19.1				35.1	%		$	15.8				33.8	%			21.1	%
Total		$	54.5				100.0	%		$	46.7				100.0	%			16.7	%

 

The real estate projects and infrastructure construction increased in the third quarter of 2013, which resulted in the higher demand for commercial vehicles. As a result, our sales to the Chinese OEM market increased by $3.6 million or 18.9%, to $22.3 million for the third quarter of 2013, compared to $18.7 million for the three month period ended September 30, 2012.

 

 

Our sales to the Chinese aftermarket increased by $0.9 million or 7.6%, to $13.1 million for the third quarter of 2013, compared to $12.2 million for the same period of 2012. The increased new vehicle sales in China and the expiration of OEM warranties helped drive our aftermarket business. Sales of our new model products, applicable to both OEM and aftermarket, also grew during the three months period ended September 30, 2013. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets. The continued urban development and the Chinese government’s support for public transportation increase the demand for buses and expand the bus aftermarket.

 

Our export sales increased by $3.3 million or 21.1%, to $19.1 million for the third quarter of 2013, as compared to $15.8 million for the same period of 2012.  To control the risk of late payment, we did not deliver orders before receiving all payments in the second quarter of 2013. With the payments received from the customers in the third quarter of 2013, our export sales increased for the three months ended September 30, 2013 compared to the same period in 2012.

 

COST OF SALES AND GROSS PROFIT

 

Cost of sales for the three months ended September 30, 2013 were $39,969,212, an increase of $6,484,153 or 19.4% from $33,485,059 for the three month period ended September 30, 2012. Our gross profit increased by 9.8% from $13,223,900 for the period of 2012 to $14,519,428 for the three months period ended September 30, 2013.

 

Gross margin decreased to 26.6% from 28.3% for the three months period ended September 30, 2013 compared with the same period in 2012. Gross margin is being affected by rising labor expenses, the appreciation of the Chinese currency, and higher raw material prices. We intend to focus in 2013 on increasing production efficiency, improving the technologies of products, and improving our product portfolio, to help us to maintain or increase our gross profit margin.

 

Cost of sales from commercial vehicle brake systems for the three months period ended September 30, 2013 was $31.8 million, an increase of $5.3 million or 19.7% from $26.5 million for the same period last year. The gross profit from commercial vehicle brake systems increased by 18.4% from $9.7 million for three months period ended September 30, 2012 to $11.5 million for the three months period ended September 30, 2013. Gross margin from commercial vehicle brake systems decreased to 26.6% from 26.9% for the three months period ended September 30, 2013 compared to the three months period ended September 30, 2012.

 

Cost of sales from passenger vehicle brake systems for the three months period ended September 30, 2013 was $8.2 million, an increase of $1.2 million or 18.2% from $7.0 million for the three months period ended September 30, 2012. The gross profit from passenger vehicle brake systems decreased by 14.2% from $3.5 million for the three months period ended September 30, 2012 to $3.0 million for the three months period ended September 30, 2013. Gross margin from passenger vehicle brake systems decreased to 26.6% from 33.4% for the three months ended September 30, 2013, as compared with 2012. The cost increase was mainly due to the increase of labor expenses, the appreciation of the Chinese currency, and higher raw material prices..

 

SELLING AND DISTRIBUTION EXPENSES

 

Selling and distribution expenses were $4,383,239 for the three months period ended September 30, 2013, as compared to $3,765,768 for the same period of 2012, an increase of $617,471 or 16.4%.

 

The increase was mainly due to increased wages expense and packaging expenses. As a percentage of sales revenue, selling expenses decreased to 8.0% for the three months ended September 30, 2013, as compared to 8.1% for the same period in 2012.

 

 

GENERAL AND ADMINISTRATIVE EXPENSES

 

General and administrative expenses were $3,696,715 for the three months period ended September 30, 2013, as compared to $2,630,786 for the same period of 2012, an increase of $1,065,929 or 40.5%. The increase was mainly due to increases in labor expenses and administrative expenses. As a percentage of sales revenue, general and administrative expenses increased to 6.8% for the three months period ended September 30, 2013, as compared to 5.6% for the same period in 2012.

 

RESEARCH AND DEVELOPMENT EXPENSE

 

Research and development expenses include payroll, employee benefits, and other personnel-related expenses associated with product development. Research and development expenses also include third-party development costs. For the three months period ended September 30, 2013, research and development expense was $2,384,902 as compared to $2,352,958 for the same period of 2012, an increase of $31,944.

 

DEPRECIATION AND AMORTIZATION

 

Depreciation and amortization expense increased to $1,992,254 for the three months period ended September 30, 2013, compared with that of $1,814,794 for the same period of 2012, an increase of $177,460. The increase in depreciation and amortization expense was primarily due to the addition of purchased production equipment.

 

FINANCIAL EXPENSE

 

Financial expense mainly consists of interest expense, the financing expense associated with our capital lease transaction and foreign currency exchange loss. The financial expense for the three months period ended September 30, 2013, increased by $229,092 to $770,418 from $541,326 for the same period of 2012, which was mainly due to increased currency exchange loss.

 

OTHER INCOME

 

Other income was $858,653 for the three months period ended September 30, 2013, as compared to $1,207,961 for the three months period ended September 30, 2012, a decrease of $349,308. The decrease was mainly due to lower sales of raw material scrap for the three months period ended September 30, 2013.

 

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 taxable income as reported in the PRC statutory financial statements in accordance with relevant income tax laws.

 

The Company increased its investment in the Joint Venture as a result of its financing conditions 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 of 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 2012 December, the Joint Venture passed the re-assessment by the government, according to the relevant PRC income tax laws. Accordingly, it continues to be taxed at a 15% rate in 2012 through 2014.

 

Income tax expense was $332,027, or an 8.2% effective tax rate, for the three months ended September 30, 2013, as compared to $1,180,601, or a 23.5% effective tax rate, for the three months ended September 30, 2012. The main reason was because the tax rate for the second quarter of 2012 was 25%, and it was 15% for the third quarter of 2013 due to renewal of the "High-Tech Enterprise" designation which was not received until December 2012.

 

 

NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTEREST IN SUBSIDIARIES

 

Noncontrolling interest in subsidiaries represents a 10% noncontrolling interest in Joint Venture and 40% noncontrolling interest in SIH, in each case held by our Joint Venture partners. Net income attributable to noncontrolling interest in subsidiaries amounted to $423,087 and $486,581 for the third quarter ended September 30, 2013 and 2012, respectively.

 

NET INCOME ATTRIBUTABLE TO STOCKHOLDERS

 

The net income attributable to stockholders for the quarter ended September 30, 2013, decreased by $50,294, to $3,310,620 from $3,360,914 for the quarter ended September 30, 2012 due to the factors discussed above. Earnings per share (“EPS”), both basic and diluted, for the quarter ended September 30, 2013 and 2012, were $0.17 and $0.17 per share, respectively.

 

Results of operations for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012.

 

SALES

 

		Nine months ended								Nine months ended
		September 30, 2013								September 30, 2012
		(U.S.  dollars in millions)
Commercial vehicles brake systems, etc.		$	124.2				81.0	%		$	111.7				77.9	%
Passenger vehicles brake systems, etc.		$	29.1				19.0	%		$	31.7				22.1	%
Total		$	153.3				100.0	%		$	143.4				100.0	%

 

Net sales were $153,317,804 and $143,399,372 for the nine months ended September 30, 2013 and 2012, respectively, an increase of $9,918,432 million or 6.9%.

 

The sales from commercial vehicle brake systems increased by $12.5 million or 11.2%, to $124.2 million for the nine months ended September 30, 2013, compared to $111.7 million for the same period of 2012. Due to increased sales in the commercial vehicle market in the nine months ended September 30, 2013, sales in the OEM market increased, which increased the sales of commercial vehicle brake systems.

 

The sales from passenger vehicle brake systems decreased by $2.6 million or 8.2%, to $29.1 million for the nine months ended September 30, 2013, compared to $31.7 million for the same period of 2012.

 

 

A breakdown of net sales revenues for China OEM markets, China Aftermarket and International markets for the nine months ended September 30, 2013 and 2012 fiscal years, respectively, is set forth below:

 

		Nine months				Percent				Nine months				Percent
		ended				of				ended				of
		September 30, 2013				Total Sales				September 30, 2012				Total Sales				Percentage Change
		(U.S. dollars in millions)
China OEM market		$	75.7				49.3	%		$	70.1				53.2	%			7.9	%
China Aftermarket		$	35.1				22.9	%		$	33.7				22.2	%			4.2	%
International market		$	42.5				27.8	%		$	39.6				24.6	%			7.4	%
Total		$	153.3				100.0	%		$	143.4				100.0	%			6.9	%

 

With the implementation of China IV emission standard beginning on July 1, 2013, the consumption of commercial vehicles equipped with China III engines spurred sales beginning in the second quarter of 2013, which resulted in higher than usual output and sales volume of commercial vehicles. The construction of real estate and infrastructure increased in the third quarter of 2013, which resulted in the higher demand of commercial vehicles. As a result, our sales to the Chinese OEM market increased by $5.5 million or 7.9%, to $75.6 million for the nine months ended September 30, 2013, compared to $70.1 million for the same period of 2012.

 

Our sales to the Chinese aftermarket increased by $1.4 million or 4.2%, to $35.1 million for the nine months ended September 30, 2013, compared to $33.7 million for the same period of 2012. The increased new vehicle sales in China and the expiration of OEM warranties helped drive the increase in our aftermarket business. Sales of our new model products, applicable to both OEM and aftermarket, also grew during the nine months ended September 30, 2013. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets. The continued urban development and the Chinese government’s support for public transportation increase the demand for buses and expand the bus aftermarket.

 

Our export sales increased by $2.9 million or 7.4%, to $42.5 million for the nine months of 2013, as compared to $39.6 million for the same period of 2012. It was mainly due to the improving conditions in the U.S. market and a broadening customer base, as well as the Company’s continuous strategy to strengthen and extend its distribution networks to focus on increasing recognition of SORL’s products by end users.

 

COST OF SALES AND GROSS PROFIT

 

Cost of sales for the nine months ended September 30, 2013 were $111,332,963, an increase of $7,552,981 or 7.3% from $103,779,982 for the same period last year. Our gross profit increased by 6.0% from $39,619,390 for the nine months ended September 30, 2013 to $41,984,841 for the same period of 2012.

 

Gross margin decreased to 27.4% from 27.6% for the nine months ended September 30, 2013, as compared with the same period of 2012. Gross margin is being affected by rising labor expenses, the appreciation of the Chinese currency, and higher raw material prices. We intend to focus in 2013 on increasing production efficiency, improving the technologies of products, and improving our product portfolio, to help us to maintain or increase our gross profit margin.

 

Cost of sales from commercial vehicle brake systems for the nine months ended September 30, 2013 was $90.9 million, an increase of $10.0 million or 12.4% from $80.9 million for the same period of 2012. The gross profit from commercial vehicle brake systems increased by 8.3% from $30.8 million for the nine months ended September 30, 2012 to $33.4 million for the same period of 2013. Gross margin from commercial vehicle brake systems decreased to 26.9% from 27.6% for the nine months ended September 30, 2013 compared with the same period of 2012.

 

 

Cost of sales from passenger vehicle brake systems for the nine months ended September 30, 2013 was $20.5 million, a decrease of $2.4 million or 10.7% from $22.9 million for the same period of 2012. The gross profit from passenger vehicle brake systems decreased by 2.3% from $8.8 million for the nine months ended September 30, 2012 to $8.6 million for the same period of 2013. Gross margin from passenger vehicle brake systems increased to 29.6% from 27.8% for the nine months ended September 30, 2013, as compared with the same period in 2012.

 

SELLING AND DISTRIBUTION EXPENSES

 

Selling and distribution expenses were $12,122,573 for the nine months ended September 30, 2013, as compared to $10,460,168 for the same period of 2012, an increase of $1,662,405 or 15.9%.

 

The increase was mainly due to increased wages expense and package expenses. As a percentage of sales revenue, selling expenses increased to 7.9% for the nine months ended September 30, 2013, as compared to 7.3% for the same period in 2012.

 

GENERAL AND ADMINISTRATIVE EXPENSES

 

General and administrative expenses were $13,079,992 for the nine months ended September 30, 2013, as compared to $9,981,552 for the same period of 2012, an increase of $3,098,440 or 31.0%.

 

The increase was mainly due to increases in labor expenses and administrative expenses. As a percentage of sales revenue, general and administrative expenses increased to 8.5% for the nine months ended September 30, 2013, as compared to 7.0% for the same period in 2012.

 

RESEARCH AND DEVELOPMENT EXPENSE

 

Research and development expenses include payroll, employee benefits, and other personnel-related expenses associated with product development. Research and development expenses also include third-party development costs. For the nine months ended September 30, 2013, research and development expenses were $5,392,513, as compared to $5,916,934 for the same period of 2012, a decrease of $524,421.

 

DEPRECIATION AND AMORTIZATION

 

Depreciation and amortization expenses increased to $5,960,145 for the nine months ended September 30, 2013, compared with that of $5,602,370 for the same period of 2012, an increase of $357,775. The increase in depreciation and amortization expenses was primarily due to the purchase of production equipment.

 

FINANCIAL EXPENSE

 

Financial expense mainly consists of interest expenses and foreign currency exchange losses. The financial expense for the nine months ended September 30, 2013, increased by $539,811 to $2,208,756 from $1,668,945 for the same period of 2012, which was mainly due to increased exchange losses.

 

OTHER INCOME

 

Other income was $1,723,767 for the nine months ended September 30, 2013, as compared to $1,972,781 for the nine months ended September 30, 2012, a decrease of $249,014. The decrease was mainly due to lower sales of raw material scrap for the nine months ended September 30, 2013.

 

 

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 taxable income as reported in the PRC statutory financial statements in accordance with relevant income tax laws.

 

The Company increased its investment in the Joint Venture as a result of its financing conditions 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 2012 December, the Joint Venture passed the re-assessment by the government, according to the relevant PRC income tax laws. Accordingly, it continues to be taxed at a 15% rate in 2012 through 2014.

 

Income tax expense was $1,040,215, or an 9.7% effective tax rate, for the nine months ended September 30, 2013, as compared to $3,479,019, or a 26.4% effective tax rate, for the nine months ended September 30, 2012. The main reason was because the tax rate for the nine months of 2012 was 25%, and it was 15% for the nine months of 2013 due to renewal of the "High-Tech Enterprise" designation which was not received until December 2012.

 

NET INCOME ATTRIBUTABLE TO NON-CONTROLLING INTEREST IN SUBSIDIARIES

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH. Each of the non-controlling interest is held by our Joint Venture partners. Net income attributable to non-controlling interest in subsidiaries amounted to $1,075,525 and $1,028,504 for the nine months ended September 30, 2013 and 2012, respectively.

 

NET INCOME ATTRIBUTABLE TO STOCKHOLDERS

 

The net income attributable to stockholders for the nine months ended September 30, 2013, decreased by $112,139, to $8,578,791 from $8,690,930 for the nine months ended September 30, 2012 due to the factors discussed above. Earnings per share (“EPS”), both basic and diluted, for the nine months ended September 30, 2013 and 2012, were $0.44 and $0.45 per share, respectively.

 

FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

OPERATING - Net cash provided by operating activities was $1,067,994 for nine months ended September 30, 2013 a decrease of $16,449,553, as compared with $17,517,547 of net cash provided by operating activities in the same period in 2012. Such decrease was primarily due to increased cash outflow resulting from changes in inventories and bank acceptance notes from customers.

 

At September 30, 2013, the Company had cash and cash equivalents of $32,520,391, as compared to cash and cash equivalents of $41,253,353 at December 31, 2012. The Company had working capital of $147,817,100 at September 30, 2013, as compared to working capital of $123,953,956 at December 31, 2012, reflecting current ratios of 4.37:1 and 3.26:1, respectively.

 

INVESTING - During the nine months ended September 30, 2013, the Company expended net cash of $3,342,250 in investing activities mainly for acquisition of new equipment to support the growth of the business. For the nine months ended September 30, 2012, the Company utilized $965,469 in investing activities.

 

 

FINANCING - During the nine months period ended September 30, 2013, the amount the Company repaid for its bank loans and capital lease obligation was $80,479,314. Cash provided by financing activities was $73,091,837 for the nine months ended September 30, 2013. Net cash used in financing activities was $7,387,477. During the nine months period ended September 30, 2012, the amount the Company repaid for bank loans and capital lease was $28,972,139. The amount the Company received from its bank loans was $23,152,945. Net cash used in financing activities was $5,819,194.

 

The Company has taken a number of steps to improve the management of its cash flow. We place more emphasis on collection of accounts receivable from our customers. We maintain good relationships with local banks. We believe that our current cash and cash equivalents and anticipated cash flow generated from operations and our bank lines of credit will be sufficient to finance our working capital requirements for the foreseeable future.

 

CURRENCY RISK AND FINANCIAL INSTRUMENTS - Although our reporting currency is the U.S. dollar, the functional currency of Joint Venture is 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 Renminbi revenues, earnings and assets, as expressed in our U.S. dollar, will decline. In recent years, the RMB has been appreciating against the U.S. dollar.

 

Assets and liabilities of our operating subsidiaries are converted into U.S. dollars at the exchange rate at the balance sheet date. The equity accounts are converted at historical exchange rate and their income and expenses items are translated using the average rate for the period. Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. Overseas contracts are primarily dominated in U.S. dollars. As a result of the RMB’s appreciation in value against U.S. dollars in the three months ended September 30, 2013, the Company’s revenue declined. The Company plans to take measures to manage its exposure to foreign currency exchange rate fluctuations, such as diversifying its customer basis overseas into different currency zones, and stipulating predetermined foreign currency exchange rates for payments to be received under its export sales contracts.

 

As the Company’s current outstanding debt obligations are primarily short-term in nature, with fixed interest rates, the Company does not have any material 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 would cause a commensurate increase in the interest expense related to such borrowings.

 

OFF-BALANCE SHEET AGREEMENTS

 

At September 30, 2013 we do 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 law of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. The Company purchased land use rights from the Ruili Group for approximately $13.9 million on September 28, 2007. The company has been negotiating with the government for a reduction in or exemption from the tax being sought by the government in connection with the transfer of the land use rights, and pending resolution of that issue, we have deferred accrual or payment of the tax. Due to the lack of resolution of that issue, the land use right certificate has not been issued to the Company. We plan to conclude negotiations with the government and to obtain the land use rights certificate as soon as practicable.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

See the discussion in Item 2 above, “Liquidity and Capital Resources”.

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures:

 

As of the end of the period covered by this report, management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”)). Based upon that evaluation, our principal executive officer and principal financial officer concluded that the disclosure controls and procedures were effective in all material respects to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management to allow their timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting:

 

There were no changes in the Company’s internal control over financial reporting during the three months ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

Not applicable.

 

ITEM 1A. RISK FACTORS.

 

Not applicable.

 

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

 

Not applicable.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

Not applicable.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

Not applicable.

 

ITEM 6. EXHIBITS

 

31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C 1350) (1)

 

 

(1)

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

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated : November 14, 2013	SORL AUTO PARTS, INC.
	By: /s/ Xiao Ping Zhang
	Name: Xiao Ping Zhang
	Title: Chief Executive Officer
	(Principal Executive Officer)
	By: /s/ Zong Yun Zhou
	Name: Zong Yun Zhou
	Title: Chief Financial Officer
	(Principal Accounting Officer)