10QSB 1 v029127_10qsb.txt -------------------------------- OMB APPROVAL -------------------------------- OMB Number: 3235-0416 Expires: March 31,2007 Estimated average burden hours per response .......182 -------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (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, 2005 -------------------------------------------------------------------------------- |_| 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 small business issuer as specified in its charter) DELAWARE 30-0091294 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) -------------------------------------------------------------------------------- No. 1169 Yumeng Road Ruian Economic Development District Ruian City, Zhejiang Province People's Republic Of China -------------------------------------------------------------------------------- (Address of principal executive offices) 86-577-65817720 -------------------------------------------------------------------------------- (Issuer' s telephone number) Check whether the issuer (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 |X| No |_| APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of November 10, 2005 there were 13,346,555 shares of Common Stock outstanding Transitional Small Business Disclosure Format (Check one): Yes |_| No |X| -------------------------------------------------------------------------------- INDEX PART I. FINANCIAL INFORMATION (unaudited)................................ 3 Item 1. Financial Statements:............................................ 3 Consolidated Balance Sheets...................................... 3 Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2005 and 2004................. 4 Consolidated Statements of Changes in Shareholders' Equity for the Third Quarter Ended on September 30, 2005 and 2004.... 5 Consolidated Statements of Cash Flows for the Third Quarter Ended September 30, 2005 and 2004................................... 6 Notes to the Consolidated Financial Statements................... 7 Item 2. Management's Discussion and Analysis or Plan of Operations....... 9 Item 3. Controls and Procedures.......................................... 15 PART II. OTHER INFORMATION................................................ 15 Item 1. Legal Proceeding................................................. 15 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...... 15 Item 3. Defaults Upon Senior Securities.................................. 16 Item 4. Submission Of Maters To a vote of Security Holders............... 16 Item 5. Other Information................................................ 16 Item 6. Exhibits......................................................... 16 SIGNATURES.................................................................. 17 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
SORL AUTO PARTS, INC. CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2005 AND DECEMBER 31, 2004 Assets December 31, September 30, 2004 2005 Unaudited Audited ---------------- -------------- Current Assets Cash and cash equivalents US$ 721,452 US$ 729,875 Account receivables, net of provision 22,864,804 12,595,905 Notes receivables 432,676 129,675 Inventory 2,720,323 1,875,300 Prepayments 1,296,602 1,404,710 Other currents (receivables, or discontinued operations) 180,443 393,300 ---------------- -------------- Total Current Assets 28,216,300 17,128,765 Fixed Assets Property, plant and equipment 9,492,870 7,517,796 Less: Accumulated depreciation (2,788,265) (2,165,142) ---------------- -------------- Fixed Assets, Net 6,704,605 5,352,654 Other Assets Intangible assets 44,078 43,174 Less: Accumulated amortization (9,998) (4,454) Intangible Assets, Net 34,080 38,720 Other LT assets (discontinued operations) -- -- Total Other Assets 34,080 38,720 Total Assets US$ 34,954,985 US$ 22,520,139 ================ ============== Liabilities and Shareholders' Equity Current Liabilities Accounts payable US$ 3,166,039 US$ 4,717,655 Deposit received from customers 1,863,476 861,624 ST bank loans 11,798,471 4,830,918 Accrued expenses 553,713 625,769 Other current liabilities 844,929 -- ---------------- -------------- Total Current Liabilities 18,226,628 11,035,966 Minority Interest 1,650,720 1,148,418 Shareholders' Equity Common stock 26,594 26,574 Paid in capital 4,147,217 4,082,237 Accumulated other comprehensive income (loss) 156,160 -- Retained earnings (deficit) 10,747,665 6,226,944 ---------------- -------------- 15,077,636 10,335,755 Total Liabilities and Shareholders' Equity US$ 34,954,985 US$ 22,520,139 ================ ==============
The accompanying notes are an integral part of the financial statements 3
SORL AUTO PARTS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THIRD QUARTER ENDED ON SEPTEMBER 30, 2005 AND 2004 2005Q3 2005 YTD 2004 Q3 2004 YTD --------------------------- -------------------------- Revenue US$ 16,376,928 45,794,109 12,595,272 33,054,188 Cost of Sales 12,909,886 35,747,428 9,706,939 25,270,118 --------------------------- -------------------------- Expenses: Selling and Distribution Expenses 849,854 2,732,863 606,780 1,622,100 General and Administrative Expenses 822,925 2,027,085 536,362 1,947,934 --------------------------- -------------------------- Total Expenses 1,672,779 4,759,948 1,143,142 3,570,034 Operating Income 1,794,263 5,286,733 1,745,191 4,214,036 Financial Expenses (145,168) (331,254) (78,125) (234,677) Non-Operating Expenses (12,642) (88,615) (13,157) (49,431) --------------------------- -------------------------- Income Before Provision for Income Taxes 1,636,453 4,866,864 1,653,909 3,929,928 Provision for Income Taxes -- -- -- -- --------------------------- -------------------------- Net Income Before Minority Interest 1,636,453 4,866,864 1,653,909 3,929,928 =========================== ========================== Minority Interest 163,645 486,686 165,391 297,137 --------------------------- -------------------------- Net Income 1,472,808 4,380,178 1,488,518 3,632,791 =========================== ========================== Foreign Currency Translation Adjustment 156,160 156,160 -- -- Minority Interest's share 15,616 15,616 -- -- --------------------------- -------------------------- Comprehensive Income (Loss) 1,613,352 4,520,721 1,488,519 3,632,791 =========================== ========================== Weighted average common share - Basic 13,297,055 13,290,388 13,287,055 13,287,055 Weighted average common share - Diluted 13,297,055 13,290,388 13,287,055 13,287,055 EPS - Basic 0.11 0.33 0.11 0.27 EPS - Diluted 0.11 0.33 0.11 0.27
The accompanying notes are an integral part of the financial statements 4
SORL AUTO PARTS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE THIRD QUARTER ENDED ON SEPTEMBER 30, 2005 AND 2004 Retained Other Number of Earnings Comprehensive Shareholders' Shares Common Stock Paid in Capital (Deficit) Income Equity -------------------------------------------------------------------------------------------------------------------- Beginning Balance - Dec. 31, 200 328,533 657 26,883,343 1,420,000 -- 28,304,000 Common Stock 12,958,522 25,917 25,917 Re-organization (22,801,106) (22,801,106) Net Income (Loss) 3,632,791 3,632,791 Other Comprehensive Income (Loss) -- -- Paid In Capital Contributions -- -------------------------------------------------------------------------------------------------------------------- Ending Balance - Sep. 30, 2004 26,574 4,082,237 5,052,791 -- 9,161,602 ==================================================================================================================== Beginning Balance - Dec 31, 200 13,287,055 26,574 4,082,237 6,226,944 -- 10,335,755 Common Stock 10,000 20 20 Net Income (Loss) 4,520,721 4,520,721 Other Comprehensive Income (Loss) 156,160 156,160 Paid In Capital Contributions 64,980 64,980 -------------------------------------------------------------------------------------------------------------------- Ending Balance - Sep. 30, 2005 13,297,055 26,594 4,147,217 10,747,665 156,160 15,077,636 ====================================================================================================================
Note: Common stock has a par value of $0.002 The accompanying notes are an integral part of the financial statements 5
SORL AUTO PARTS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THIRD QUARTER ENDED ON SEPTEMBER 30, 2005 AND 2004 2005 2004 ---------------- ------------- Cash Flows from Operating Activities Net Income (Loss) US$ 4,520,721 US$ 3,632,791 Adjustments to reconcile net income (loss to net cash from operating activities: Amortization 5,544 (3,323) Depreciation 623,123 351,410 Changes in Assets and Liabilities: Account Receivables (10,268,899) (11,725,129) Notes Receivables (303,001) (1,469,862) Other Receivables 212,857 (100,159) Inventory (845,023) (380,950) Prepayments, Deposits, and Other Current Assets 108,108 1,719,360 Account Payables (1,551,615) (4,275,039) Deposits Received from Customers 1,001,852 3,085,319 Other Payables and Accrued Expenses 772,873 25,501,713 Minority Interest 502,302 848,137 ---------------- ------------- Net Cash Flows from Operating Activities (5,221,158) 25,734,346 Cash Flows from Investing Activities Acquisition of Property and Equipment (1,975,074) (278,779) Investment in Intangible Assets (905) (28,343) ---------------- ------------- Net Cash Flows from Investing activities (1,975,979) (307,122) Cash Flows from Financing Activities Proceeds from Borrowings 6,967,553 (2,175,812) Proceeds from Share Issuance 20 25,917 Paid-in capital increase 64,980 (22,801,106) ---------------- ------------- Net Cash flows from Financing Activities 7,032,553 (24,951,001) Accumulated other Comprehensive Income 156,160 Net Increase (Decrease) in Cash (8,424) 476,224 Cash - Beginning of the term 729,875 -- ---------------- ------------- Cash - End of the term 721,452 476,224 ================ ============= Supplemental Cash Flow Disclosures Interest Paid 139,286 79,124 Tax Paid -- -- ---------------- -------------
6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company's financial position as of September 30, 2005 and the results of its operations and cash flows, for the nine months ended September 30, 2005 and 2004 have been made. Operating results for the nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005. These condensed financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Form 10-KSB for the year ended December 31, 2004. 2. DESCRIPTION OF BUSINESS SORL Auto Parts (the "Company") is principally engaged in the manufacture and distribution of automotive air brake valves and hydraulic brake valves for vehicles weighing more than three tons, such as trucks, vans and buses, through its 90% ownership of Ruian Group Ruian Auto Parts Company Limited ("Ruian") in the PRC. The Company distributes products both in China and internationally under SORL Auto Parts trademarks. The Company's product range includes 36 categories of brake valves with over 800 different specifications. 3. SEASONAL BUSINESS The Company's operations in China are seasonal due to Chinese holidays. Consequently, the three months ended March 31, 2005 and 2004 have been the Company's slowest period. 4. FOREIGN CURRENCY TRANSLATION The Company maintains its books and accounting records in Renminbi ("RMB"), the currency of the People's Republic of China. The Company's functional currency is also RMB. Translation of financial statement amounts from RMB to the Company's reporting currency, United States dollars ("US$"), has been made at the exchange rate of US$1 to RMB8.11, based on the most recent announcement made by the People's Bank of China on July 21, 2005. Assets and liabilities items denominated in foreign currency are translated to the functional currency at the prevailing exchange rate at the balance sheet date. Revenue and expenses are translated at the weighted average rate in effect on the transaction dates. Foreign currency gains and losses, if any, are included in the determination of net income for the period, i.e., in the account of other comprehensive income. The RMB is not readily convertible into US dollar or other foreign currencies. The foreign exchange rate between the US$ and the RMB has been stable at approximately US$1 to RMB8.28 for the last few years. No representation is made that the RMB amounts could have been or could be, converted into United States dollars or any other currency at that rate or any other rate. 7 5. STOCK-BASED COMPENSATION In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment" ("SFAS 123R"). SFAS 123R revises FASB Statement No. 123 "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25 "Accounting for Stock Issued to Employees". SFAS 123R requires all public and non-public companies to measure and recognize compensation expense for all stock-based payments for services received at the grant-date fair value, with the cost recognized over the vesting period (or the requisite service period). The Company has adopted SFAS 123R on its consolidated financial statements. 6. RECENTLY ISSUED ACCOUNTING STANDARDS Interpretation No. 46 "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51" (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. FIN 46 does not have any impact on the financial position or results of operations of the Company. In April 2003, the FASB issued SFAS No. 149, "Accounting for Amendment of statement 133 on Derivative Instruments and Hedging Activities," which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133, accounting for Derivative Instruments and Hedging Activities. This Statement is generally effective for contracts entered into or modified after June 30, 2003, and all provisions should be applied prospectively. This statement does not affect the Company. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. This statement does not affect the Company. In November 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 151 "Inventory Costs - an amendment of ARB No. 43, Chapter 4" ("SFAS 151"). This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that those items be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to costs of conversion be based upon the normal capacity of the production facilities. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2006. The Company is currently evaluating the impact of SFAS 151 on its consolidated financial statements. 7. RELATED PARTY TRANSACTIONS The following related party transactions occurred for the three quarters ended September 30, 2005: the Company purchased $11.5M finished products and $0.3M packaging materials from Ruili Group; sold $3.3M products to Ruili Group for the three quarters ended September 30, 2005. The Company purchased $5.7M finished products and $0.5M packaging materials from Ruili Group for the three quarters ended September 30, 2004. 8 8. OTHER MATTERS In January 2004, the Ruili Group underwent a corporate reorganization to restructure its business (the "Reorganization"). Pursuant to the Reorganization, the Ruili Group and Fairford Holdings Limited ("Fairford"), a company incorporated on November 3, 2003, in Hong Kong with limited liability, with identical shareholders as the Ruili Group, established Ruili Group Ruian Auto Parts Co., Ltd., in the PRC as a Sino-foreign equity joint venture company with limited liability (the Company) on March 4, 2004. As part of the Reorganization, the Ruili Group transferred to the JV Company the business of manufacture and sale of various kinds of automobile valves and related operations together with the relevant assets and liabilities (the "Transferred Business") effective from January 19, 2004. This was accomplished by transferring the relevant assets and liabilities of the Transferred Business including trade receivables, inventories, plant and machineries, and short and long-term borrowings from the Ruili Group to Fairford at a consideration of $6,406,780. Fairford then injected these relevant assets and liabilities as capital contribution for 90% interest of the JV Company. The remaining 10% capital contribution resulted from the Ruili Group's additional inventories. The assets and liabilities injected into the JV Company by the Ruili Group and Fairford represented all the relevant assets and liabilities of the Transferred Business. The Ruili Group retained ownership of certain assets and liabilities including land use rights, buildings, prepayment and deposits of real estate investments, bank balances, borrowings, claims and contingent liabilities (collectively the "Non-transferred Business"). The net assets of discontinued operations were transferred to stockholders at $22,160,876. PART II ITEM 2. MANAGEMENT'S DISCUSSION & ANALYSIS OR PLAN OF OPERATION 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 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 projected. Undue reliance should not be place 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 consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-QSB. 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. 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 is considered to be the accounting acquirer. As such, the following results of operations are those of Fairford. 9 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 the People's Republic of China ("PRC" or "China"). The Joint Venture is a joint venture between Fairford and Ruili Group Co., Ltd. (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 the Ruian District of Wenzhou City, 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 Chairman and Chief Executive Officer of the Company. The Joint Venture was established in the PRC on March 4, 2004 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 in the aggregate amount of US$7,100,000. 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, plant and machinery, and the assumption of short and long term borrowings, at a consideration of US$6,390,000. The consideration was based on a valuation by an independent PRC valuation firm. Fairford then injected these assets and liabilities as a 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. Certain historical information of the Transferred Business is based on the operation of such Business when it was owned by the Ruili Group. 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, Fairford maintains operating control over the Joint Venture. As a result of the foregoing, through Fairford's 90% interest in the Joint Venture, the Company manufactures and distributes automotive air brake valves and hydraulic brake valves in China and internationally for use primarily in vehicles weighing over three tons, such as trucks, vans and buses. There are thirty-six categories of valves with over eight hundred different specifications. Management believes that it is the largest manufacturer of automotive brake valves in China. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Below is a description of accounting policies, which we consider critical to the preparation and understanding of our financial statements. In addition, certain amounts included in or affecting our financial statements and related disclosure must be estimated, which requires us to make assumptions with respect to values or conditions which cannot be known with certainty at the time the financial statements are prepared. Actual results may differ from these estimates under different assumptions or conditions. The selection of critical accounting policies, the judgments and other uncertainties affecting the application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our consolidated financial statements. 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. 10 ACCOUNTING METHOD The Company uses the accrual method of accounting which recognizes revenues when earned and expenses when incurred. TRADE RECEIVABLES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS The Company presents trade receivables, net of allowances for doubtful accounts. The allowances are calculated based on review of individual customer accounts. 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 moving-average cost if it exceeds the net realizable value. INCOME TAXES Taxes are calculated in accordance with taxation principles currently effective in the PRC. The Company accounts for income taxes using the liability method. 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 in the period that includes the enactment date. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized. Under Tax Holiday, the Company is granted exemption form income tax for two years commencing from the first cumulative profit-making year and 50% reduction in the local income tax rate in the following three years. 2004 is the first accumulative profit-making year. SORL is entitled to 50% income tax reduction in 2006, 2007 and 2008. Thereafter, the applicable income tax rate is 26.40% in Wenzhou city which is located in the coastal economic development zones. REVENUE RECOGNITION In accordance with the provisions of Staff Accounting Bulletin No. 103, revenue is recognized when merchandise is shipped and title passes to the customer and collectibility is reasonably assured. Revenues consist of the invoice value of the sale of goods and services net of value added tax, rebates and discounts. The Company is subject to the following surtaxes, which are recorded as deductions from gross sales: Education Tax. The Company does not receive revenue for shipping and handling to customers. Shipping and handling expenses incurred by the Company are included in selling and administrative expenses in the accompanying consolidated statements of income. 11 CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of trade 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 collectibility of outstanding accounts receivable. RESULTS OF OPERATIONS (1) FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 SALES Sales for the quarter ended September 30, 2005 increased by $3.8 million or 30% to $16.4 million from September 30, 2004, primarily as a result of the increase in the sales volume or the units sold particularly from export (outside of China) sales. The export sales accounted for 88% of the total quarter sales increase, while the domestic sales increase accounted for 12% of total quarter increase. COST OF SALES Cost of sales for the quarter ended September 30, 2005 increased to $12.9M from $9.7M from the quarter ended September 30, 2004, representing a 33% increase. The cost increase was consistent with the increase in sales revenue. GROSS PROFIT Gross profit for the quarter ended September 30, 2005 increased by $0.58M to $3.47M from $2.89M for the quarter ended September 30, 2004. This increase in gross profit was primarily due to the increase in the sales both in the domestic (China) and international market. However, the gross profit margin decreased to 21% in the quarter ended September 30, 2005 from 23% in the comparable quarter in 2004, primarily as a result of the RMB appreciation against the US dollar in the context of a much larger amount of export sales denominated in US dollars, as well as an increasing portion of distribution of products not manufactured by the Company itself (which carries a lower margin). Although the gross margin of distribution was at 4% on average, it represents an important value-added service to existing customers by offering to them a wider range of products and saving customers' transaction costs. As part of its short term strategy and in an effort to gain market share and brand recognition, the Company has not increased the prices of its products to offset the currency appreciation. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses for the quarter ended September 30, 2005 was $1.7M or 10% of total net sales compared to $1.1M or 9% of total net sales for the quarter ended September 30, 2004. The increase in expenses was consistent with the growth of the business. In the current quarter, the Company charged $65,000 to general & administrative expense (from the issuance of 10,000 shares at a market price of $6.50 per share on June 30, 2005 for financial advisory services). DEPRECIATION AND AMORTIZATION Depreciation and amortization expenses during the quarter ended September 30, 2005 were $182,000, approximately the same as that of the quarterly depreciation & amortization expenses of $182,000 in 2004. 12 INTEREST EXPENSE Interest expense for the quarter ended September 30, 2005 increased by $60,000 to $139,000 from $79,000 from the quarter ended September 30, 2004. The increase in interest expense is due to the higher debt balance over the year. INCOME TAX There was no income tax for both the quarters ended September 30, 2005 and 2004. As a result of the Joint Venture (i.e. Ruili Group Auto Parts Co., Ltd.) obtaining its foreign joint-venture status in 2004, it is exempted from PRC income tax in both fiscal 2004 and 2005. MINORITY INTEREST Minority Interest represents a 10% non-controlling interest in the Joint Venture. Minority Interest in income amounted to US$164,000 and US$165,000 for the quarters ended September 30, 2005 and 2004, respectively. NET INCOME Net income for the quarter ended September 30, 2005 decreased by $16,000, representing a 1% decrease in a net income in $1.47M from net income of $1.49M for the quarter ended September 30, 2004 due to the factors discussed above. (2) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 SALES Sales for the three quarters ended September 30, 2005 increased by $12.7 million or 39% to $45.8 million, primarily as a result of the increase in the volume of products shipped. Export sales increased approximately 86%, constituting 60% of the total sales increase. COST OF SALES Cost of sales for the three quarters ended September 30, 2005 increased to $35.7M from $25.3M for the three quarters ended September 30, 2004, or a 41% increase. The cost increase was consistent with the changes in the operation. GROSS PROFIT Gross profit for the three quarters ended September 30, 2005 increased by $2.2M or 28% to $10.0M from $7.8M for the three quarters ended September 30, 2004. This increase in gross profit was primarily due to the increase in the sales both in the domestic and international market. However, the gross margin dropped 2% from 24% to 22% because of the RMB appreciation against the US dollar by 2%, as well as the increase in the distribution of products not manufactured by the Company by $5.8M which carried an average 4% gross margin. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses for the three quarters ended September 30, 2005 was $4.8M or 10% of net sales compared to $3.6M or 11% of net sales for the three quarters ended September 30, 2004. The decrease in selling, general and administrative expenses as a percentage of net sales was due primarily to the economies of scale resulting from the increase in sales. 13 DEPRECIATION AND AMORTIZATION Depreciation and amortization expense increased to $575,000 for the three quarters ended September 30, 2005, compared to the depreciation and amortization expense of $512,000 for the three quarters ended September 30, 2004. INTEREST EXPENSE Interest expense for the three quarters ended September 30, 2005 increased by $96,000 to $331,000 from $235,000 for the three quarters ended September 30, 2004. The increase in interest expense was due to the higher debt balance over the year. INCOME TAX There was no income tax for the three quarters ended September 30, 2005 and 2004. As a result of the Joint Venture obtaining its foreign joint-venture status in 2004, it is exempted from PRC income tax in both fiscal 2004 and 2005. MINORITY INTEREST Minority Interest represents a 10% non-controlling interest in the Joint Venture. Minority Interest in income amounted to $487,000 and $297,000 for the three quarters ended September 30, 2005 and 2004, respectively. NET INCOME The net income for the three quarters ended September 30, 2005 increased by $747,000, or 20% to a net income of $4.4M from a net income of US$3.6M for the three quarters ended September 30, 2004 due to the factors discussed above. FINANCIAL CONDITION (1) LIQUIDITY AND CAPITAL RESOURCES OPERATING - The Company's operations utilized cash resources of $5,221,159 for the three quarters ended September 30, 2005, as compared to generating cash resources of $25,734,345 for the three quarters ended September 30, 2004, primarily as a result of that cash generated in 2005 was consumed to support the increase of receivables and inventory and reduce the accounts payables. At September 30, 2005, the Company had cash and cash equivalents of $721,452, as compared to cash and cash equivalents of $476,233 at September 30, 2004. The Company had working capital of $9,989,672 at September 30, 2005, as compared to a working capital deficiency of $10,057,296 at September 30, 2004, reflecting current ratios of 1.55:1 and 0.86:1, respectively. The improvement in working capital for the three quarters ended September 30, 2005 was primarily a result of the growth of profit. The Company anticipates that its working capital resources are adequate to fund the anticipated costs and expenses for the remainder of the fiscal year ending December 31, 2005. INVESTING - for the three quarters ended September 30, 2005, the Company utilized $1,975,074 in the acquisition of property and equipment to support the growth of its business. During the nine months ended September 30, 2004, the Company utilized $307,122 in investing activities. 14 FINANCING - for the three quarters ended September 30, 2005, the Company generated $6,967,553 from bank loans; for the three quarters ended September 30, 2004, the Company paid off $2,175,812 in debt. At September 30, 2005, the Company does not have any material commitments for capital expenditures or have any transactions, obligations or relationships that could be considered off-balance sheet arrangements. (2) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not have any market risk with respect to such factors as commodity prices, equity prices, and other market changes that affect market risk sensitive investments. With respect to foreign currency exchange rates, the Company does not believe that the 2% appreciation or fluctuation of the RMB against the United States recently occurring will have a detrimental effect on the Company's operation even though the Company's export business represents almost one third its revenues. 9. AS THE COMPANY'S 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 WOULD CAUSE A COMMENSURATE INCREASE IN THE INTEREST EXPENSE RELATED TO SUCH BORROWINGS. ITEM 3. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and Chief Financial Officer, after evaluating our disclosure controls and procedures (as defined in the rules and regulation of the Securities and Exchange Commission under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-QSB, have concluded that as of such date, our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. (b) Changes in Internal Controls. During the period covered by the Quarterly Report on Form 10-QSB, there were no significant changes in our internal controls over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. None. ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS. None. 15 ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS. (a) Exhibits: 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 16 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 11, 2005 SORL AUTO PARTS, INC. By: /s/ Xiao Ping Zhang -------------------------------- Name: Xiao Ping Zhang Title: Chief Executive Officer 17