10-Q 1 v473037_10q.htm 10-Q

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

xQUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended June 30, 2017

 

¨

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

 

For the transition period from _________ to _________

 

Commission file number 000-11991

 

SORL AUTO PARTS, INC.

(Exact name of registrant as specified in its charter)

 

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

 

No. 2666 Kaifaqu Avenue

Ruian Economic Development District

Rui’an 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

 

Emerging Growth Company ¨

 

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

 

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

Yes ¨  No 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 August 14 , 2017 there were 19,304,921 shares of Common Stock outstanding

 

 

 

 

 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Quarter Ended June 30, 2017

 

INDEX

 

    Page
     
PART I. FINANCIAL INFORMATION (Unaudited)  
     
Item 1. Financial Statements:  
     
  Consolidated Balance Sheets as of June 30, 2017 (Unaudited) and December 31, 2016 3
     
  Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2017 and 2016 (Unaudited) 4
     
  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016 (Unaudited) 5
     
  Consolidated Statements of Changes in Equity for the Six months Ended June 30, 2017 (Unaudited) 6
     
  Notes to Consolidated Financial Statements (Unaudited) 7
     
Item 2. Management’s Discussion and Analysis or Financial Condition and Results of Operations 19
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
     
Item 4. Controls and Procedures 25
     
PART II. OTHER INFORMATION 26
     
Item 1. Legal Proceedings. 26
     
Item 1A. Risk Factors. 26
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 26
     
Item 3. Defaults Upon Senior Securities. 26
     
Item 4. Mine Safety Disclosures. 26
     
Item 5. Other Information. 26
     
Item 6. Exhibits 26
     
SIGNATURES 27

 

 2 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2017 and December 31, 2016

 

   June 30, 2017   December 31, 2016 
   (Unaudited)     
Assets          
Current Assets          
Cash and cash equivalents  US$7,892,336   US$8,057,155 
Accounts receivable, net, including $0 and $5,025,509 from related parties at June 30, 2017 and December 31, 2016, respectively   121,195,863    102,129,294 
Bank acceptance notes receivable   55,051,719    42,697,276 
Inventories   84,010,792    65,776,517 
Prepayments, current   5,505,494    10,797,601 
Restricted cash   362,390    5,476,621 
Other current assets   4,402,609    1,124,608 
Deferred tax assets   3,282,926    3,210,575 
Total Current Assets   281,704,129    239,269,647 
           
Property, plant and equipment, net   64,897,237    53,737,706 
Land use rights, net   8,364,804    8,309,333 
Intangible assets, net   7,279    11,438 
Prepayments, non-current   16,530,890    - 
Total Non-current Assets   89,800,210    62,058,477 
Total Assets  US$371,504,339   US$301,328,124 
           
Liabilities and Equity          
Current Liabilities          
Accounts payable and bank acceptance notes to vendors, including $4,063,994 and $1,953,707 due to related parties at June 30, 2017 and December 31, 2016, respectively  US$66,616,160   US$65,672,626 
Deposit received from customers   31,797,486    22,733,742 
Short term bank loans   47,005,701    27,416,376 
Income tax payable   1,466,131    996,522 
Accrued expenses   17,999,096    20,103,392 
Due to related party   23,299,371    - 
Other current liabilities   2,517,997    2,013,943 
Total Current Liabilities   190,701,942    138,936,601 
           
Total Liabilities   190,701,942    138,936,601 
           
Equity          
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of June 30, 2017 and December 31, 2016   -    - 
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of June 30, 2017 and December 31, 2016   38,609    38,609 
Additional paid-in capital   (28,582,654)   (28,582,654)
Reserves   16,414,768    15,129,935 
Accumulated other comprehensive income   9,838,499    6,117,042 
Retained earnings   157,916,027    146,352,530 
Total SORL Auto Parts, Inc. Stockholders' Equity   155,625,249    139,055,462 
Noncontrolling Interest In Subsidiaries   25,177,148    23,336,061 
Total Equity   180,802,397    162,391,523 
Total Liabilities and Equity  US$371,504,339   US$301,328,124 

 

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

 

 3 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Income and Comprehensive Income

For The Three and Six Months Ended June 30, 2017 and 2016 (Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2017   2016   2017   2016 
                 
Sales  US$90,214,630   US$73,535,732   US$164,110,411   US$127,372,460 
Include: sales to related parties   900,859    3,968,105    3,927,783    6,548,951 
Cost of sales   66,507,343    52,941,316    119,855,419    92,338,965 
Gross profit   23,707,287    20,594,416    44,254,992    35,033,495 
                     
Expenses:                    
Selling and distribution expenses   8,985,562    7,125,085    14,594,185    12,687,517 
General and administrative expenses   4,710,522    4,909,129    8,755,435    11,838,987 
Research and development expenses   2,481,563    2,379,962    4,536,659    4,123,649 
Total operating expenses   16,177,647    14,414,176    27,886,279    28,650,153 
                     
Other operating income, net   1,253,856    1,484,939    2,042,324    2,399,144 
                     
Income from operations   8,783,496    7,665,179    18,411,037    8,782,486 
                     
Interest income   11,475    925,586    22,025    1,013,688 
Government grants   84,395    140,255    113,304    145,012 
Other income   50    845,165    714    890,754 
Interest expenses   (542,176)   (126,113)   (1,023,336)   (300,573)
Other expenses   (442,608)   (129,663)   (650,139)   (767,292)
                     
Income before income taxes provision   7,894,632    9,320,409    16,873,605    9,764,075 
                     
Income taxes provision   1,311,509    1,277,277    2,597,683    1,242,453 
                     
Net income  US$6,583,123   US$8,043,132   US$14,275,922   US$8,521,622 
                     
Net income attributable to noncontrolling interest in subsidiaries   658,312    804,313    1,427,592    852,162 
                     
Net income attributable to common stockholders  US$5,924,811   US$7,238,819   US$12,848,330   US$7,669,460 
                     
Comprehensive income:                    
                     
Net income  US$6,583,123   US$8,043,132   US$14,275,922   US$8,521,622 
Foreign currency translation adjustments   3,223,520    (4,596,167)   4,134,952    (3,489,527)
Comprehensive income   9,806,643    3,446,965    18,410,874    5,032,095 
Comprehensive income attributable to noncontrolling interest in subsidiaries   980,664    344,696    1,841,087    503,209 
Comprehensive income attributable to common stockholders  US$8,825,979   US$3,102,269   US$16,569,787   US$4,528,886 
                     
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$0.31   US$0.37   US$0.67   US$0.40 
                     
EPS - diluted  US$0.31   US$0.37   US$0.67   US$0.40 

 

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

 

 4 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For The Six Months Ended June 30, 2017 and 2016 (Unaudited)

 

   Six Months Ended June 30, 
   2017   2016 
         
Cash Flows From Operating Activities          
Net income  US$14,275,922   US$8,521,622 
Adjustments to reconcile net income to net cash used in operating activities:          
           
Allowance for doubtful accounts   381,715    5,399,425 
Depreciation and amortization   4,187,811    3,436,677 
Deferred income tax   4,566    (950,451)
           
Changes in assets and liabilities:          
Accounts receivable   (16,819,493)   (19,302,545)
Bank acceptance notes receivable   3,181,918    (14,353,761)
Other currents assets   (3,197,226)   566,936 
Inventories   (16,436,720)   14,139,460 
Prepayments, current   4,815,945    (7,284,955)
Prepaid capital lease interest   -    69,239 
Accounts payable and bank acceptance notes to vendors   (395,358)   1,817,414 
Income tax payable   438,458    1,466,704 
Deposits received from customers   8,402,222    3,782,517 
Other current liabilities and accrued expenses   (2,087,738)   535,090 
Net Cash Flows Used In Operating Activities   (3,247,978)   (2,156,628)
           
Cash Flows From Investing Activities          
Change in short term investments   -    57,261,374 
Acquisition and prepayments of property, plant, and equipment and land use rights   (29,561,593)   (7,315,047)
Advance to related party   -    (18,247,384)
Repayment of advance to related party   -    18,247,384 
Change in restricted cash   5,198,792    377,608 
Net Cash Flows Provided By (Used In) Investing Activities   (24,362,801)   50,323,935 
           
Cash Flows From Financing Activities          
Proceeds from bank loans   41,540,998    31,796,224 
Repayment of bank loans   (23,035,449)   (29,597,070)
Distribution to controlling shareholder in connection with plant and land use rights exchange with entity under common control   -    (70,781,668)
Repayment of capital lease   -    (1,779,040)
Proceeds from related party   62,786,671    - 
Repayment to related party   (54,076,148)   - 
Net Cash Flows Provided By (Used In) Financing Activities   27,216,072    (70,361,554)
           
Effects on changes in foreign exchange rate   229,888    271,744 
           
Net change in cash and cash equivalents   (164,819)   (21,922,503)
           
Cash and cash equivalents - beginning of the period   8,057,155    30,230,828 
           
Cash and cash equivalents - end of the period  US$7,892,336   US$8,308,325 
           
Supplemental Cash Flow Disclosures:          
Interest paid  US$785,502   US$450,677 
Income taxes paid  US$2,154,659   US$1,288,659 
           
Non-cash Investing and Financing Transactions:          
Transfer of plant and land use right to entity under common control  US$-   US$17,342,372 
Liabilities assumed in connection with the plant and land use right exchange  US$-   US$5,351,196 
Loans from related party in the form of bank acceptance notes  US$14,375,855   US$- 

 

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

 

 5 

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Equity

For The Six Months Ended June 30, 2017 (Unaudited)

 

           Additional           Accumulated
Other
   Total SORL Auto         
   Number of   Common   Paid-in       Retained   Comprehensive   Parts, Inc.   Noncontrolling     
   Share   Stock   Capital   Reserves   Earnings   Income   Stockholders' Equity   Interest   Total Equity 
Balance as of December 31, 2016   19,304,921   $38,609   $(28,582,654)  $15,129,935   $146,352,530   $6,117,042   $139,055,462   $23,336,061   $162,391,523 
                                              
Net income   -    -    -    -    12,848,330    -    12,848,330    1,427,592    14,275,922 
                                              
Foreign currency translation adjustment   -    -    -    -    -    3,721,457    3,721,457    413,495    4,134,952 
                                              
Transfer to reserve   -    -    -    1,284,833    (1,284,833)   -    -    -    - 
                                              
Balance as of June 30, 2017   19,304,921   $38,609   $(28,582,654)  $16,414,768   $157,916,027   $9,838,499   $155,625,249   $25,177,148   $180,802,397 

 

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

 

 6 

 

 

SORL Auto Parts, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2017

(Unaudited)

 

NOTE A - DESCRIPTION OF BUSINESS

 

SORL Auto Parts, Inc. (together with its subsidiaries, “we,” “us,” “our” or the “Company” or “SORL”), a Delaware corporation incorporated on March 24, 1982, is principally engaged in the manufacture and distribution of vehicle brake systems and other key safety-related components, through its 90% ownership of Ruili Group Ruian Auto Parts Co., Ltd. (the “Joint Venture” or “Ruian”). The Company distributes products both in China and internationally under SORL trademarks. The Company’s product range includes 65 categories and over 2,000 different specifications.

 

The Joint Venture was formed in the People’s Republic of China (“PRC” or “China”) as a Sino-Foreign joint venture on January 17, 2004, pursuant to the terms of a Joint Venture Agreement between the Ruili Group Co., Ltd. (the “Ruili Group”), a related party under common control, and Fairford Holdings Limited (“Fairford”), a wholly owned subsidiary of the Company. The Ruili Group was incorporated in China in 1987 and specializes in the development, production and sale of various kinds of automotive parts. Fairford and the Ruili Group contributed 90% and 10%, respectively, of the paid-in capital of the Joint Venture.

 

On November 11, 2009, the Company, through its wholly owned subsidiary, Fairford, entered into a joint venture agreement with MGR Hong Kong Limited (“MGR”), a Hong Kong-based global auto parts distribution specialist firm and an unaffiliated Taiwanese individual investor. The joint venture was named SORL International Holding, Ltd. (“SIH”) based in Hong Kong. SORL held a 60% interest in the joint venture, MGR held a 30% interest, and the Taiwanese individual investor held a 10% interest. SIH was primarily devoted to expanding SORL's international sales network in Asia-Pacific and creating a larger footprint in Europe and Africa with a target to create a truly global distribution network. In December 2015, due to the poor financial performance of SIH, Fairfold sold all of its interest in SIH to the Taiwanese investor. After this transaction, SIH ceased to be a distributor of SORL in the international market.

 

NOTE B - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

(1)BASIS OF PRESENTATION

 

The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All intercompany balances and transactions have been eliminated in the consolidation. Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted as permitted by the rules and regulations of the United States Securities and Exchange Commission (“SEC”), although the Company believes that the disclosures contained in this report are adequate to make the information presented not misleading. The consolidated balance sheet information as of December 31, 2016 was derived from the consolidated audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. These consolidated financial statements should be read in conjunction with the annual consolidated audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, and other reports filed with the SEC.

 

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

 

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(2)SIGNIFICANT ACCOUNTING POLICIES

 

a. ACCOUNTING METHOD

 

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

 

b. USE OF ESTIMATES

 

The preparation of financial statements in conformity with U.S generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management makes its best estimate of the outcome for these items based on historical trends and other information available when the financial statements are prepared. Changes in estimates are recognized in accordance with the accounting rules for the estimate, which is typically in the period when new information becomes available to management. Actual results could differ from those estimates.

 

c. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

For certain of the Company’s financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, bank acceptance notes receivable, inventories, current prepayments, other current assets, deferred tax assets, accounts payable and bank acceptance notes to vendors, short term bank loans, deposit received from customers, income tax payable, accrued expenses and other current liabilities, the carrying amounts approximate fair values due to their short maturities.

 

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

 

d. RESTRICTED CASH

 

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

 

e. RELATED PARTY TRANSACTIONS

 

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

 

f. BANK ACCEPTANCE NOTES RECEIVABLE

 

Bank acceptance notes receivable, generally due within six months and with specific payment terms and definitive due dates, are comprised of the notes issued by some customers to pay certain outstanding receivable balances to the Company, and the notes issued by the customers of Ruili Group and transferred to the Company as loans from related party. Bank acceptance notes do not bear interest. As of June 30, 2017 and December 31, 2016, bank acceptance notes receivable in the amount of $45,552,031 and $32,916,198, respectively, were pledged to banks to issue either short term bank loans or bank acceptance notes to vendors. The banks charge discount fees if the Company chooses to discount the bank acceptance notes for cash before the maturity of the notes and such discount fees are included in interest expenses.

 

 8 

 

 

g. REVENUE RECOGNITION

 

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

 

h. COST OF SALES

 

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

 

i. FOREIGN CURRENCY TRANSLATION

 

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

 

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

 

NOTE C – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

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

 

 9 

 

 

NOTE D - RELATED PARTY TRANSACTIONS

 

The Company continues to purchase primarily packaging materials from the Ruili Group. The Ruili Group is the minority stockholder of Joint Venture and is collectively controlled by Mr. Xiao Ping Zhang, his wife, Ms. Shu Ping Chi, and his brother, Mr. Xiao Feng Zhang. In addition, the Company purchases automotive components from four other related parties, Guangzhou Kormee Automotive Electronic Control Technology Co., Ltd. (“Guangzhou Kormee”), Ruian Kormee Automobile Braking Co., Ltd. (“Ruian Kormee”), Ruili MeiLian Air Management System (LangFang) Co., Ltd. (“Ruili MeiLian”) and Shanghai Dachao Electric Technology Co., Ltd. (“Shanghai Dachao”). Guangzhou Kormee and Ruili MeiLian are controlled by the Ruili Group and Ruian Kormee is the wholly-owned subsidiary of Guangzhou Kormee. Ruili Group owns 49% equity interest in Shanghai Dachao. The Company sells certain automotive products to the Ruili Group. The Company also sells scrap materials and parts to Guangzhou Kormee, Ruian Kormee and Ruili MeiLian.

 

The following related party transactions occurred for the three and six months ended June 30, 2017 and 2016:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2017   2016   2017   2016 
PURCHASES FROM:                    
Guangzhou Kormee Automotive Electronic Control Technology Co., Ltd.  $989,679   $294,970   $1,325,606   $687,894 
Ruian Kormee Automobile Braking Co., Ltd.   401,132    226,591    756,803    357,104 
Ruili MeiLian Air Management System (LangFang) Co., Ltd.   1,373,241        2,156,311     
Shanghai Dachao Electric Technology Co., Ltd.           55,230    33,744 
Ruili Group Co., Ltd.   1,382,956    1,079,955    2,509,674    1,945,753 
Total Purchases  $4,147,008   $1,601,516   $6,803,624   $3,024,495 
                     
SALES TO:                    
Guangzhou Kormee Automotive Electronic Control Technology Co., Ltd.  $972,084   $1,026,611   $1,749,441   $1,644,457 
Ruian Kormee Automobile Braking Co., Ltd.   12,187        12,187    573 
Ruili MeiLian Air Management System (LangFang) Co.,Ltd   388,287        388,287     
Ruili Group Co., Ltd.   900,859    3,968,105    3,927,783    6,548,951 
Total Sales  $2,273,417   $4,994,716   $6,077,698   $8,193,981 

 

During the three and six months ended June 30, 2017 and 2016, for the sales mentioned above, the sales to Guangzhou Kormee, Ruian Kormee and Ruili MeiLian were sales of scrap materials and parts, and the related operating results were included in other operating income, net in the consolidated statements of income and comprehensive income. The sales to Ruili Group were included in sales in the consolidated statements of income and comprehensive income.

 

 10 

 

 

   June 30,   December 31, 
   2017   2016 
ACCOUNTS RECEIVABLE FROM RELATED PARTIES          
Ruili Group Co., Ltd.  $   $4,361,010 
Guangzhou Kormee Automotive Electronic Control Technology Co., Ltd.       664,499 
Total  $   $5,025,509 
           
ACCOUNTS PAYABLE AND BANK ACCEPTANCE NOTES TO RELATED PARTIES          
Ruian Kormee Automobile Braking Co., Ltd.  $832,606   $628,310 
Guangzhou Kormee Automotive Electronic Control Technology Co., Ltd.   1,161,913     
Shanghai Dachao Electric Technology Co., Ltd.   280    100,441 
Ruili MeiLian Air Management System (LangFang) Co., Ltd   2,069,195    1,224,956 
Total  $4,063,994   $1,953,707 

 

DUE TO RELATED PARTY

 

Due to related party consisted of the following:

 

   June 30,   December 31, 
   2017   2016 
Ruili Group Co., Ltd.  $23,299,371   $ 
Total  $23,299,371   $ 

 

The balance of due to related party represents the loans the Company obtained from Ruili Group in the form of cash and bank acceptance notes for working capital purposes. The loans owed to the related party are interest free, unsecured and repayable on demand. During the six months ended June 30, 2017, the Company obtained the loans in the amount of $62,786,671 in cash and $14,375,855 in bank acceptance notes and repaid $54,076,148 in cash. The effect of changes in foreign exchange rate is $212,993.

 

 11 

 

 

The Company entered into a lease agreement with Ruili Group, see Note K for more details.

 

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

 

The Company provided a guarantee for the credit line granted to Ruili Group by the China Merchants Bank in the amount of RMB 50,000,000 (approximately $7,699,889) for a period from July 29, 2015 until two years after the due date of each loan withdrawn by Ruili Group under the credit line. The credit line was replaced by the one issued by the same bank in the amount of RMB 40,000,000 (approximately $5,766,181) for a period of 12 months starting on October 24, 2016, the guarantee of which was continued to be provided by the Company as of June 30, 2017.

 

The Company provided a guarantee for the credit line granted to Ruili Group by China Guangfa Bank in the amount of RMB 200,000,000 (approximately $28,830,907) for the period from May 22, 2016 to May 22, 2017. As of June 30, 2017, the guarantee was released as the credit line was fully paid off by Ruili Group.

 

The Company provided a guarantee for the credit line granted to Ruili Group by China Guangfa Bank in a maximum amount of RMB 69,000,000 (approximately $10,092,000) for the period from November 16, 2016 to November 16, 2018.

 

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

 

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

 

NOTE E - ACCOUNTS RECEIVABLE, NET

 

Accounts receivable, net consisted of the following:

 

   June 30,   December 31, 
   2017   2016 
Accounts receivable  $133,548,015   $113,815,711 
Less: allowance for doubtful accounts   (12,352,152)   (11,686,417)
Accounts receivable, net  $121,195,863   $102,129,294 

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the six months ended June 30, 2017 and 2016. The changes in the allowance for doubtful accounts at June 30, 2017 and December 31, 2016 are summarized as follows:

 

   June 30,   December 31, 
   2017   2016 
Beginning balance  $11,686,417   $12,075,402 
Add: increase to allowance   381,715    395,491 
Effects on changes in foreign exchange rate   284,020    (784,476)
Ending balance  $12,352,152   $11,686,417 

 

 12 

 

 

NOTE F – INVENTORIES

 

At June 30, 2017 and December 31, 2016, inventories consisted of the following:

 

   June 30,   December 31, 
   2017   2016 
Raw materials  $21,829,534   $20,121,513 
Work-in-process   13,134,775    14,843,653 
Finished goods   49,046,483    30,811,351 
Total inventories  $84,010,792   $65,776,517 

 

NOTE G - PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment consisted of the following at June 30, 2017 and December 31, 2016:

 

   June 30,   December 31, 
   2017   2016 
Machinery  $103,063,924   $87,694,677 
Molds   1,288,032    1,257,841 
Office equipment   2,097,303    2,021,982 
Vehicles   2,980,904    2,246,203 
Buildings   16,206,613    15,826,738 
Leasehold improvements   469,572    458,566 
Sub-total   126,106,348    109,506,007 
           
Less: accumulated depreciation   (61,209,111)   (55,768,301)
           
Property, plant and equipment, net  $64,897,237   $53,737,706 

 

Depreciation expense charged to operations was $4,041,628 and $3,265,445 for the six months ended June 30, 2017 and 2016, respectively.

 

In May 2016, the Company, through its principal operating subsidiary, entered into a Purchase Agreement with Ruili Group, pursuant to which the Company agreed to exchange the land use rights and factory facilities located at No. 1169 Yumeng Road, Rui'an Economic Development Zone, Rui'an City, Zhejiang Province, the People's Republic of China (the “Dongshan Facility”), purchased in 2007 from Ruili Group, plus RMB 501.0 million (approximately $76.5 million) in cash for the land use rights and factory facilities located at No. 2666 Kaifaqu Avenue, Rui’an Economic Development Zone, Rui’an City, Zhejiang Province, the People’s Republic of China (the “Development Zone Faciliy”). As of the filing date, the Company has not obtained the property ownership certificate or land use right certificate of the Development Zone Facility. The Company reserved the relevant tax amount of RMB 4,560,000 (approximately $745,220) for the Dongshan Facility and RMB 15.0 million (approximately $2.3 million) for the Development Zone Facility. These amounts were determined based on a 3% tax rate on the consideration paid for the Dongshan Facility and the Development Zone Facility in the transactions, which the Company considered as the most probable amount of tax liability.

 

 13 

 

 

NOTE H - DEFERRED TAX ASSETS

 

Deferred tax assets consisted of the following as of June 30, 2017 and December 31, 2016:

 

   June 30,   December 31, 
   2017   2016 
Deferred tax assets - current          
           
Allowance for doubtful accounts  $1,922,409   $1,798,894 
Revenue (net of cost)   26,995    76,719 
Unpaid accrued expenses   216,951    357,352 
Warranty   1,116,571    977,610 
Deferred tax assets   3,282,926    3,210,575 
Valuation allowance        
           
Deferred tax assets - current  $3,282,926   $3,210,575 

 

Deferred taxation is calculated under the liability method in respect of taxation effect arising from all timing differences, which are expected with reasonable probability to realize in the foreseeable future. The Company and its subsidiaries do not have income tax liabilities in U.S. as the Company had no taxable income for the reporting periods. 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 June 30, 2017 and December 31, 2016:

 

   June 30,   December 31, 
   2017   2016 
Secured  $47,005,701   $27,416,376 

 

The Company obtained those short term loans from Bank of China, Bank of Ningbo, Agricultural Bank of China, China Zheshang Bank, and China Construction Bank, respectively, to finance general working capital as well as new equipment acquisition. Interest rate for the loans outstanding during the six months ended June 30, 2017 ranged from 0.55% to 4.60% per annum. The maturity dates of the loans existing as of June 30, 2017 ranged from July 3, 2017 to June 14, 2018. As of June 30, 2017 and December 31, 2016, the Company’s accounts receivables of $4,480,490 and $4,484,755, respectively, were pledged as collateral under loan arrangements. In addition, the Company also pledged bank acceptance notes of $11,350,540 as collateral under loan arrangements, as of June 30, 2017. The interest expenses for short-term bank loans were $542,176 and $82,431 for the three months ended June 30, 2017 and 2016, respectively. The interest expenses for short-term bank loans were $1,003,088 and $158,129 for the six months ended June 30, 2017 and 2016, respectively.

 

 14 

 

 

As of June 30, 2017, corporate or personal guarantees provided for those bank loans were as follows:

 

$2,588,616   Guaranteed by Ruili Group, a related party
      
$2,035,605   Pledged by Ruili Group, a related party, with its land and buildings. Guaranteed by Ruili Group, a related party, and Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both of who are the Company’s principal stockholders.
      
$2,884,388   Pledged by Ruili Group, a related party, with its land and buildings. Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both of who are the Company’s principal stockholders.
      
$6,889,171   Guaranteed by Ruili Group, a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both of who are the Company’s principal stockholders.
      
$11,350,540   Pledged by the Company with its bank acceptance notes.
      
$11,809,164   Pledged by Hangzhou Ruili Zhiye Development Ltd., a related party under common control of Ruili Group, with its property. Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both of who are the Company’s principal stockholders.
      
$5,904,582   Pledged by the Company with its land and property. Guaranteed by Ruili Group, a related party, and Mr. Xiao Ping Zhang, who is the Company’s principal stockholder.
      
$3,543,635   Pledged by the Company with its accounts receivable. Guaranteed by Ruili Group, a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both of who are the Company's principal stockholders.

 

NOTE J - INCOME TAXES

 

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

 

In 2015, the Joint Venture was awarded the Chinese government's "High-Tech Enterprise" designation for a third time, which is valid for three years and it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017.

 

The reconciliation of the effective income tax rate of the Company to the statutory income tax rate in the PRC for the six months ended June 30, 2017 and 2016 is as follows:

 

   Six Months Ended
June 30, 2017
   Six Months Ended
June 30, 2016
 
US statutory income tax rate   35.00%   35.00%
Valuation allowance recognized with respect to the loss in the US company   -35.00%   -35.00%
China statutory income tax rate   25.00%   25.00%
Effects of income tax exemptions and reliefs   -10.00%   -10.0%
Effects of additional deduction allowed for R&D expenses   -1.90%   -3.16%
Effects of expenses not deductible for tax purposes   0.63%   0.51%
Other items   1.66%   0.37%
Effective tax rate   15.39%   12.72%

 

 15 

 

 

Income taxes are calculated on a separate entity basis. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. There currently is no tax benefit recorded for the United States. The tax authority may examine the tax returns of the Company three years after the year ended December 31, 2015. In the six months ended June 30, 2017, 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 six months ended June 30, 2017 and 2016, respectively, are summarized as follows:

 

   Six Months Ended
June 30, 2017
   Six Months Ended
June 30, 2016
 
         
Current  $2,610,023   $2,203,680 
Deferred   (12,340)   (961,227)
           
Total  $2,597,683   $1,242,453 

 

ASC 740-10 requires recognition and measurement of uncertain income tax positions using a “more-likely-than-not” approach. The management evaluated the Company’s tax positions and considered that no provision for uncertainty in income taxes was necessary as of June 30, 2017 and December 31, 2016.

 

NOTE K – OPERATING LEASE WITH RELATED PARTY

 

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

 

The lease expenses were $487,794 and $796,829 for the six months ended June 30, 2017 and 2016, respectively.

 

NOTE L - WARRANTY CLAIMS

 

Warranty claims were $1,416,614 and $1,172,033 for the six months ended June 30, 2017 and 2016, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The movement of accrued warranty expenses for the six months ended June 30, 2017 was as follows:

 

Beginning balance at January 1, 2017  $6,517,402 
Aggregate increase for new warranties issued during current period   1,416,614 
Aggregate reduction for payments made   (657,227)
Effect of exchange rate fluctuation   167,016 
Ending balance at June 30, 2017  $7,443,805 

 

NOTE M – SEGMENT INFORMATION

 

The Company produces brake systems and other related components for different types of commercial vehicles (“Commercial Vehicle Brake Systems”). On August 31, 2010, the Company through Ruian, executed an Asset Purchase Agreement to acquire, and purchased, a segment of the passenger vehicle auto parts business (“Passenger Vehicle Brake Systems”) of Ruili Group. As a result of this acquisition, the Company's product offerings were expanded to both commercial and passenger vehicles' brake systems and other key safety-related auto parts.

 

 16 

 

 

The Company has two operating segments: Commercial Vehicle Brake Systems and Passenger Vehicle Brake Systems.

 

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

 

   Six Months Ended June 30, 
   2017   2016 
         
SALES TO EXTERNAL CUSTOMERS          
Commercial vehicles brake systems  $136,869,275   $103,378,620 
Passenger vehicles brake systems   27,241,136    23,993,840 
           
Sales  $164,110,411   $127,372,460 
           
INTERSEGMENT SALES          
Commercial vehicles brake systems  $   $ 
Passenger vehicles brake systems        
           
GROSS PROFIT          
Commercial vehicles brake systems  $36,979,900   $28,771,643 
Passenger vehicles brake systems   7,275,092    6,261,852 
Gross profit  $44,254,992   $35,033,495 
Selling and distribution expenses   14,594,185    12,687,517 
General and administrative expenses   8,755,435    11,838,987 
Research and development expenses   4,536,659    4,123,649 
           
Other operating income, net   2,042,324    2,399,144 
           
Income from operations   18,411,037    8,782,486 
           
Interest income   22,025    1,013,688 
Government grants   113,304    145,012 
Other income   714    890,754 
Interest expenses   (1,023,336)   (300,573)
Other expenses   (650,139)   (767,292)
Income before income tax expense  $16,873,605   $9,764,075 
           
CAPITAL EXPENDITURE          
Commercial vehicles brake systems  $24,631,178   $5,914,317 
Passenger vehicles brake systems   4,930,415    1,400,730 
           
Total  $29,561,593   $7,315,047 
           
DEPRECIATION AND AMORTIZATION          
Commercial vehicles brake systems  $3,489,621   $2,792,836 
Passenger vehicles brake systems   698,190    643,841 
           
Total  $4,187,811   $3,436,677 
           
   June 30, 2017   December 31, 2016 
     
TOTAL ASSETS          
Commercial vehicles brake systems  $313,772,565   $248,023,179 
Passenger vehicles brake systems   57,731,774    53,304,945 
           
Total  $371,504,339   $301,328,124 
           
   June 30, 2017   December 31, 2016 
     
LONG LIVED ASSETS          
Commercial vehicles brake systems  $75,845,257   $51,080,332 
Passenger vehicles brake systems   13,954,953    10,978,145 
           
Total  $89,800,210   $62,058,477 

 

 17 

 

 

NOTE N – CONTINGENCIES

 

(1) The Company purchased the Dongshan Facility from Ruili Group in 2007 and subsequently transferred the plants and land use right to Ruili Group. The Company has never obtained the land use right certificate nor the property ownership certificate of the building for the Dongshan Facility. The Company reserved the relevant tax amount of RMB 4,560,000 (approximately $745,220). This amount was determined based on a 3% tax rate on the consideration paid for the Dongshan Facility in the transaction, which the Company considered as the most probable amount of tax liability. The Dongshan Facility was transferred back to Ruili Group on May 5, 2016.

 

(2) The information of lease commitments is provided in Note K.

 

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

 

NOTE O – SUBSEQUENT EVENTS

 

On July 4, 2017, Ruian, a subsidiary of the Company, obtained the plants and associated land use rights it purchased from Yunding Holding Group Co., Ltd. in cash at a purchase price of RMB60.06 million (approximately US$8.87 million). The related stamp duty and deed tax were also fully paid by the Company as of June 30, 2017. The plants and associated land use rights will be used to meet Ruian's growing operational needs and is located in International Auto Parts District (east district), Tangxia Town, Ruian City, Zhejiang Province, China with a land use area of 33,141.00 square meters and a building floor area of 25,016.11 square meters. The land use rights will expire on March 23, 2046. The total cash payments are included as prepayments, non-current in the accompanying unaudited consolidated balance sheets.

 

During the subsequent period, the Company obtained totaling approximately $15,794,000 short term loans from Bank of China, Agricultural Bank of China, Oversea-Chinese Banking Corp., and China Construction Bank to finance general working capital as well as new non-current assets acquisitions. Interest rates for those loans range from 2.75% to 4.39% per annum. The maturity dates of the loans existing as of the filing date ranged from December 9, 2017 to August 8, 2018. As of the filing date, the Company pledged accounts receivable and bank acceptance notes of approximately $2,273,000 and $3,690,000, respectively, as collateral under the above loan arrangements.

 

In the same period, the Company repaid loan principals as well as interests of totaling approximately $5,014,000 to Bank of China and Agricultural Bank of China.

 

 18 

 

 

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

 

The following is management’s discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying consolidated unaudited financial statements, as well as information relating to the plans of our current management. The following discussion and analysis should be read in conjunction with our consolidated unaudited financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-Q.

 

FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q includes forward-looking statements. Any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Generally, the words “believe,” “anticipate,” “may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar expressions, or the negative thereof, or comparable terminology, are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including the matters set forth in this report or other reports or documents we file with SEC from time to time, which could cause actual results or outcomes to differ materially from those anticipated. Some of the factors that could cause actual results to differ include: our ability to effectively implement our business strategy; our ability to handle downward pricing pressures on our products; and our ability to accurately or effectively plan our production or supply needs. For a discussion of these and all other known risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which is available on the SEC’s website at www.sec.gov. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to revise or update these forward-looking statements.

 

OVERVIEW

 

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

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

For a summary of our accounting policies and estimates, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the Year ended December 31, 2016.

 

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

 

Results of Operations

 

Sales

 

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

 

   Three Months Ended   Three Months Ended 
   June 30, 2017   June 30, 2016 
   (U.S.  dollars in millions) 
     
Commercial Vehicle Brake Systems  $76.2    84.5%  $59.3    80.6%
Passenger Vehicle Brake Systems  $14.0    15.5%  $14.2    19.4%
                     
Total  $90.2    100.0%  $73.5    100.0%

 

 19 

 

 

   Six Months Ended   Six Months Ended 
   June 30, 2017   June 30, 2016 
   (U.S.  dollars in millions) 
     
Commercial Vehicle Brake Systems  $136.9    83.4%  $103.4    81.2%
Passenger Vehicle Brake Systems  $27.2    16.6%  $24.0    18.8%
                     
Total  $164.1    100.0%  $127.4    100.0%

 

The sales were $90.2 million and $73.5 million for the three months ended June 30, 2017 and 2016, respectively, an increase of $16.7 million or 22.7%. The sales were $164.1 million and $127.4 million for the six months ended June 30, 2017 and 2016, respectively, an increase of $36.7 million or 28.8%. The increase was mainly due to the increased sales of commercial vehicle brake systems.

 

The sales from Commercial Vehicle Brake Systems increased by $16.9 million or 28.5%, to $76.2 million for the second fiscal quarter of 2017, compared to $59.3 million for the same period of 2016. The sales from Commercial Vehicle Brake Systems increased by $33.5 million or 32.4%, to $136.9 million for the six months ended June 30, 2017, compared to $103.4 million for the six months ended June 30, 2016. Our high quality, low cost products continued to generate higher sales and further penetrated into the commercial vehicle market, which impacted the sales of the commercial vehicle brake systems.

 

The sales from Passenger Vehicle Brake Systems decreased by $0.2 million or 1.4%, to $14.0 million for the second fiscal quarter of 2017, compared to $14.2 million for the same period of 2016. The sales from Passenger Vehicle Brake Systems increased by $3.2 million or 13.3%, to $27.2 million for the six months ended June 30, 2017, compared to $24.0 million for the same period of 2016. The increase was mainly due to the increase of passenger vehicle market.

 

A breakdown of the sales revenue for these markets for the second fiscal quarter of the 2017 and 2016, respectively, is set forth below:

 

   Three
Months
   Percent   Three
Months
   Percent     
   Ended   of   Ended   of     
   June 30,
2017
   Total
Sales
   June 30,
2016
   Total
Sales
   Percentage
Change
 
   (U.S. dollars in millions)     
         
China OEM market  $47.3    52.4%  $36.7    49.9%   28.9%
China Aftermarket  $22.7    25.2%  $18.9    25.7%   20.1%
International market  $20.2    22.4%  $17.9    24.4%   12.8%
Total  $90.2    100.0%  $73.5    100.0%   22.7%

 

 20 

 

 

A breakdown of the sales revenues for China OEM markets, China aftermarket and international market for the six months ended June 30, 2017 and 2016, respectively, is set forth below:

 

   Six Months   Percent   Six Months   Percent     
   Ended   of   Ended   of     
   June 30,
2017
   Total
Sales
   June 30,
2016
   Total
Sales
   Percentage
Change
 
   (U.S. dollars in million)     
         
China OEM market  $89.1    54.3%  $64.9    50.9%   37.3%
China Aftermarket  $40.8    24.9%  $32.1    25.2%   27.1%
International market  $34.2    20.8%  $30.4    23.9%   12.5%
Total  $164.1    100.0%  $127.4    100.0%   28.8%

 

Considering the increase of the production and sales of the commercial vehicle market, our sales to the Chinese OEM market increased by 28.9%, from the second fiscal quarter of 2016, to $47.3 million. Our sales to the Chinese OEM market increased by 37.3% from the six months ended June 30, 2017, to $89.1 million.

 

Our sales to the China aftermarket increased by $3.8 million or 20.1%, to $22.7 million for the second fiscal quarter of 2017, compared to $18.9 million for the same period of 2016. Our sales to the China aftermarket increased by $8.7 million or 27.1%, to $40.8 million for the six months ended June 30, 2017, compared to $32.1 million for the same period of 2016. The increased new vehicle sales in China and the expiration of OEM warranties helped to drive our aftermarket business. Accelerated urbanization and the Chinese government’s increased support for public transportation favor our expansion in the bus aftermarket. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets.

 

Our export sales increased by $2.3 million or 12.8%, to $20.2 million for the second fiscal quarter of 2017, as compared to $17.9 million for the same period of 2016. Our export sales increased by $3.8 million or 12.5%, to $34.2 million for the six months ended June 30, 2017, as compared to $30.4 million for the same period of 2016. The increase in export sales was mainly due to our broadened customer base.

 

Cost of Sales and Gross Profit

 

Cost of sales for the three months ended June 30, 2017 were $66.5 million, an increase of $13.6 million or 25.6% from $52.9 million for the three month period ended June 30, 2016. Cost of sales for the six months ended June 30, 2017 were $119.9, an increase of $27.5 million or 29.8% from $92.3 million for the same period in 2016.

 

Our gross profit increased by 15.1% from $20.6 million for the three months ended June 30, 2016 to $23.7 million for the three month period ended June 30, 2017. Our gross profit increased by 26.3% from $35.0 million for the six months ended June 30, 2016 to $44.3 million for the same period of 2017.

 

Gross margin decreased to 26.3% from 28.0% for the three months period ended June 30, 2017 compared to 2016. Gross margin decreased to 27.0% from 27.5% for the six months ended June 30, 2017, as compared to the same period of 2016. To strengthen our competitiveness and increase our market share, we enhanced the price promotion for the six months ended June 30, 2017. We intend to focus in 2017 on increasing production efficiency, improving the technologies of products, and improving our product portfolio, to help us to maintain or increase our gross profit margins.

 

Cost of sales from Commercial Vehicle Brake Systems for the three months period ended June 30, 2017 was $55.6 million, an increase of $13.1 million or 30.9% from $42.5 million for the same period last year. Cost of sales from Commercial Vehicle Brake Systems for the six months ended June 30, 2017 was $99.9 million, an increase of $25.3 million or 33.9% from $74.6 million for the same period of 2016. The gross profit from Commercial Vehicle Brake Systems increased by 22.4% from $16.8 million for three month period ended June 30, 2016 to $20.6 million for the three month period ended June 30, 2017. The gross profit from Commercial Vehicle Brake Systems increased by 28.5% from $28.8 million for the six months ended June 30, 2016 to $37.0 million for the same period of 2017. Gross margin from Commercial Vehicle Brake Systems decreased to 27.0% from 28.3% for the three months period ended June 30, 2017 compared to the three months period ended June 30, 2016. Gross margin from Commercial Vehicle Brake Systems decreased to 27.0% from 27.8% for the six months ended June 30, 2017 compared with the same period of 2016.

 

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Cost of sales from Passenger Vehicle Brake Systems for the three months period ended June 30, 2017 was $10.9 million, an increase of $0.4 million or 4.2% from $10.5 million for the three month period ended June 30, 2016. Cost of sales from Passenger Vehicle Brake Systems for the six months ended June 30, 2017 was $20.0 million, an increase of $2.3 million or 12.6% from $17.7 million for the same period of 2016. The gross profit from Passenger Vehicle Brake Systems decreased by 17.3% from $3.8 million for the three month period ended June 30, 2016 to $3.1 million for the three month period ended June 30, 2017. The gross profit from Passenger Vehicle Brake Systems increased by 16.2% from $6.3 million for the six months ended June 30, 2016 to $7.3 million for the same period of 2017. Gross margin from Passenger Vehicle Brake Systems decreased to 22.3% from 26.6% for the three months ended June 30, 2017 compared to the three months period ended June 30, 2016. Gross margin from Passenger Vehicle Brake Systems increased to 26.7% from 26.1% for the six months ended June 30, 2017, as compared with the same period in 2016.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were $9.0 million for the three months ended June 30, 2017, as compared to $7.1 million for the same period of 2016, an increase of $1.9 million or 26.1%. Selling and distribution expenses were $14.6 million for the six months ended June 30, 2017, as compared to $12.7 million for the same period of 2016, an increase of $1.9 million or 15.0%. The increase was mainly due to increased packaging expenses, repair fees, and product warranty fees.

 

As a percentage of sales revenue, selling expenses increased to 10.0% for the three months ended June 30, 2017, as compared to 9.7% for the same period in 2016. As a percentage of sales revenue, selling expenses decreased to 8.9% for the six months ended June 30, 2017, as compared to 10.0% for the same period in 2016.

 

General and Administrative Expenses

 

General and administrative expenses were $4.7 million for the three months ended June 30, 2017, as compared to $4.9 million for the same period of 2016, a decrease of $0.2 million or 4.0%. General and administrative expenses were $8.8 million for the six months ended June 30, 2017, as compared to $11.8 million for the same period of 2016, a decrease of $3.0 million or 26.0%. The decrease was mainly due to the decrease in allowance for doubtful accounts for the six months ended June 30, 2017.

 

As a percentage of sales revenue, general and administrative expenses decreased to 5.2% for the three months ended June 30, 2017, as compared to 6.7% for the same period in 2016. As a percentage of sales revenue, general and administrative expenses decreased to 5.3% for the six months ended June 30, 2017, as compared to 9.3% for the same period in 2016.

 

Research and Development Expenses

 

Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development costs. For the three months ended June 30, 2017, research and development expenses were $2.5 million, as compared to $2.4 million for the same period of 2016, an increase of $0.1 million. For the six months ended June 30, 2017, research and development expenses were $4.5 million, as compared to $4.1 million for the same period of 2016, an increase of $0.4 million.

 

Other Operating Income

 

Other operating income was $1.3 million for the three months ended June 30, 2017, as compared to $1.5 million for the three months ended June 30, 2016, a decrease of $0.2 million. Other operating income was $2.0 million for the six months ended June 30, 2017, as compared to $2.4 million for the six months ended June 30, 2016, a decrease of $0.4 million. The decrease was mainly due to a decrease in sales of raw material scrap.

 

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Depreciation and Amortization

 

Depreciation and amortization expense increased to $2.2 million for the three months ended June 30, 2017, compared with that of $1.7 million for the same period of 2016, an increase of $0.5 million. Depreciation and amortization expenses increased to $4.2 million for the six months ended June 30, 2017, compared with that of $3.4 million for the same period of 2016, an increase of $0.8 million. The increase in depreciation and amortization expenses was primarily due to the purchase of production equipment and the land and factory transaction with Ruili Group which occurred in May of 2016.

 

Interest income

 

The interest income for the three months ended June 30, 2017, decreased by $0.9 million to $0.01 million, compared with the same period of 2016. The interest income for the six months ended June 30, 2017, decreased by $1.0 million to $0.02 million, compared with the same period of 2016. The decrease was primarily due to the decreased short term investments during the period.

 

Interest Expenses

 

The interest expenses for the three months ended June 30, 2017, increased by $0.4 million to $0.5 million from $0.1 million for the same period of 2016. The interest expenses for the six months ended June 30, 2017, increased by $0.7 million to $1.0 million from $0.3 million for the same period of 2016, mainly due to increased interest rate and increased amount of average loans outstanding during the period.

 

Income Tax

 

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

 

In 2009, the Joint Venture was awarded the Chinese government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate for years 2009 through 2011. In December 2012, the Joint Venture passed the re-assessment of the High-Tech Enterprise certificate by the government, according to the relevant PRC income tax laws. Accordingly, it continued to be taxed at a 15% rate in 2012 through 2014. The Company used a tax rate of 25% for the first three quarters of 2015. In the fourth quarter of 2015, the Joint Venture passed the re-assessment by the government, based on PRC income tax laws. Accordingly, it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017. The current income tax rate used by the Company for the six months ended June 30, 2017 is 15%.

 

Income tax expense was $1.3 million for the three months ended June 30, 2017, as compared to $1.3 million for the three months ended June 30, 2016. Income tax expense was $2.6 for the six months ended June 30, 2017, as compared to $1.2 for the six months ended June 30, 2016.

 

Net Income Attributable to Non-Controlling Interest in Subsidiaries

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH, in each case held by our joint venture partners. On December 15, 2015, the Company disposed of its entire 60% equity interest in SIH. Net income attributable to noncontrolling interest in subsidiaries amounted to $0.7 million and $0.8 million for the second fiscal quarter ended June 30, 2017 and 2016, respectively. Net income attributable to non-controlling interest in subsidiaries amounted to $1.4 million and $0.9 million for the six months ended June 30, 2017 and 2016, respectively.

 

Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the fiscal quarter ended June 30, 2017, decreased by $1.3 million, to $5.9 million from $7.2 million for the fiscal quarter ended June 30, 2016 due to the factors discussed above. The net income attributable to stockholders for the six months ended June 30, 2017, increased by $5.1 million, to $12.8 million from $7.7 million for the six months ended June 30, 2016 due to the factors discussed above. Earnings per share (“EPS”), both basic and diluted, for the fiscal quarter ended June 30, 2017 and 2016, were $0.31 and $0.37, respectively. EPS, both basic and diluted, for the six months ended June 30, 2017 and 2016, were $0.67 and $0.40, respectively.

 

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FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

As of June 30, 2017, the Company had cash and cash equivalents of $7.9 million, as compared to cash and cash equivalents of $8.1 million as of December 31, 2016. The Company had working capital of $91.0 million at June 30, 2017, as compared to working capital of $100.3 million at December 31, 2016, reflecting current ratios of 1.48:1 and 1.72:1, respectively.

 

OPERATING - Net cash used in operating activities was $3.2 million for six months ended June 30, 2017, an increase of $1.0 million, as compared with $2.2 million of net cash used in operating activities in the same period in 2016. Such increase was primarily due to the increased cash outflow resulted by changes in inventories.

 

INVESTING - During the six months ended June 30, 2017, the Company expended net cash of $24.4 million in investing activities mainly for acquisitions of property, plant, and equipment and land use right. For the six months ended June 30, 2016, the Company received net cash of $50.3 million in investing activities.

 

FINANCING - During the six month period ended June 30, 2017, the cash provided by financing activities was $27.2 million. Cash used in financing activities was $70.4 million for the six months ended June 30, 2016.

 

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

 

OFF-BALANCE SHEET ARRANGEMENTS

 

As of June 30, 2017, we did not have any material commitments for capital expenditures or have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.

 

According to the laws of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. In 2007, the Company purchased the land use rights from the Ruili Group, a related party. The Company also purchased the buildings on the land in the same transaction. The purchase price of land use right and building amounted to approximately $20 million. On May 5, 2016, the Company entered into a Purchase Agreement with the Ruili Group through Ruian, pursuant to which the Company agreed to exchange the Dongshan Facility plus RMB501 million (approximately $76.5 million) in cash for Development Zone Facility. The value for the Dongshan Facility and Development Zone Facility were appraised to be RMB125 million (approximately $19.1 million) and RMB626 million (approximately $95.6 million), respectively. As of June 30, 2017, total amount of RMB481 million (approximately 73.5 million) was paid to the Ruili Group in installments, and the remaining RMB20 million (approximately $3.0 million) will be paid within 10 days of completion of the required procedures for transferring the title of the facilities and the land use rights as specified in the Purchase Agreement.

 

Even if the Company is unable to timely resolve obtain the land use right certificate for the land and related building, the Company believes that there will be no potential adverse implication on the Company for the following reasons.

 

1.The Company acquired the land use rights in a transaction between the Company and the Ruili Group, a related party. The Ruili Group, as the original land use right owner, has granted the land use right to the Company by contract which is supported by valid consideration.

 

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

 

a)The Ruili Group promised that the Company has the right to use the land and related building, even before the land use certificate is transferred.
b)According to the laws of China, the government owns all the land and the buildings attached to the land in China. Once the land use right is granted to Ruili Group, Ruili Group has the right to assign its land use rights to any third parties, including the Company, without interference from the government. Therefore, it is unlikely that the government will oppose the Company’s right to use the land and related building.
c)The Company has reserved tax payables in the amount of RMB 19,590,000 (approximately US$2,891,580) on its consolidated balance sheets under the line item “accrued expenses” as if no reduction or exemption of tax is approved. This amount was determined based on a 3% tax rate on the consideration paid for the land use right in the transaction, which the Company considered as the most probable amount of tax liability. This amount also represented the maximum amount of tax the Company expects to pay if the negotiation with the local government ultimately is not successful.

 

CONTRACTUAL OBLIGATIONS

 

As of June 30, 2017, we had no material changes outside the ordinary course of business in our contractual obligations

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures:

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs. As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of June 30, 2017 was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(b) and 15d-15(b) of the Exchange Act). Based on this evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures, as of June 30, 2017, were effective, in all material respects, for the purpose stated above.

 

Changes in Internal Control over Financial Reporting:

 

There were no changes in the Company’s internal control over financial reporting during the three months ended June 30, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None.

 

ITEM 1A. RISK FACTORS

 

Not applicable.

 

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

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

3.1   Amended and Restated Articles of Incorporation, as further amended (approved May 27, 2010). (1)
     
3.2   Amended and Restated Bylaws effective as of March 14, 2009. (2)
     
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32   Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (3)
     
101.1NS   XBRL Instance Document    
     
101.SCH   XBRL Taxonomy Extension Schema Document    
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document    
     
101.DEF   XBRL Taxonomy Extension Definitions Linkbase Document    
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document    
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

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

 

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

  

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

 

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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 : August 14, 2017 SORL AUTO PARTS, INC.
   
  By: /s/ Xiao Ping Zhang
  Name: Xiao Ping Zhang
  Title: Chief Executive Officer
  (Principal Executive Officer)
   
  By: /s/ Zong Yun Zhou
  Name: Zong Yun Zhou
  Title: Chief Financial Officer
  (Principal Accounting Officer)

 

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