By law and practice, when
improvements are made to real property and those improvements are permanently affixed to the property, the title to those improvements
automatically transfers to the owner of the property. The lessee’s interest in the improvements is not a direct ownership
interest but rather it is an intangible right to use and benefit from the improvements during the term of the lease. The leasehold
improvements are amortized over the lease term.
In May 2009, Ruian entered
into a lease agreement with Ruili Group Co., Ltd. for the lease of a manufacturing plant. This manufacturing plant was not
part of the assets acquired from Ruili Group Co., Ltd. The lease term is from September 2009 to May 2017.
In August 2009, SIH entered
into a lease agreement with MGR for the lease of an office with a five-year lease term.
In August 2010, a new
a lease agreement was signed between Ruian and Ruili Group Co., Ltd., under which Ruian leased 32,410 square meters manufacturing
plant for its new purchased passenger vehicles brake systems business. The lease term is from September 2009 to August 2020.
NOTE I- LAND USE RIGHTS
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
Cost:
|
|
$
|
16,908,792
|
|
|
$
|
16,676,941
|
|
Less: Accumulated amortization:
|
|
|
(2,055,212
|
)
|
|
|
(1,934,894
|
)
|
Land use rights, net
|
|
$
|
14,853,580
|
|
|
$
|
14,742,047
|
|
According to the law of
China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through
land use rights granted by the Chinese government. The Company purchased the land use rights from Ruili Group for approximately
$13.9 million on September 28, 2007.
The company has been negotiating with the government for a reduction
in or exemption from the tax being sought by the government in connection with the transfer of the land use rights, and pending
resolution of that issue, we have deferred accrual or payment of the tax. Due to the lack of resolution of that issue, the land
use right certificate has not been issued to the Company. We plan to conclude negotiations with the government and to obtain the
land use rights certificate as soon as practicable. Amortization expenses were $92,774 and $85,538 for the three months ended March
31, 2013 and 2012, respectively.
NOTE J - INTANGIBLE ASSETS
Intangible assets owned
by the Company included patent technology and management software licenses. Amortization expenses were $4,244 and $4,188
for the three months ended March 31, 2013 and 2012, respectively. Future estimated amortization expense is as follows:
2013
|
|
|
2014
|
|
|
2015
|
|
|
2016
|
|
|
2017
|
|
|
Thereafter
|
|
$
|
12,528
|
|
|
$
|
13,574
|
|
|
$
|
11,990
|
|
|
$
|
11,990
|
|
|
$
|
9,128
|
|
|
$
|
3,465
|
|
NOTE K - PREPAYMENTS
Prepayments consisted
of the following as of March 31, 2013 and December 31, 2012:
|
|
March 31,
2013
|
|
|
December 31,
2012
|
|
Raw material suppliers
|
|
$
|
4,874,506
|
|
|
$
|
4,659,154
|
|
Equipment purchases
|
|
|
1,058,843
|
|
|
|
1,063,589
|
|
|
|
|
|
|
|
|
|
|
Total prepayments
|
|
$
|
5,933,349
|
|
|
$
|
5,722,743
|
|
NOTE L - DEFERRED TAX ASSETS AND DEFERRED
TAX LIABILITIES
Deferred tax assets consisted
of the following as of March 31, 2013 and December 31, 2012 comprise the following:
|
|
March 31, 2013
|
|
|
December 31, 2012
|
|
Deferred tax assets - current
|
|
|
|
|
|
|
|
|
Provision
|
|
|
192,284
|
|
|
|
156,673
|
|
Warranty
|
|
|
595,853
|
|
|
|
568,161
|
|
Deferred tax assets
|
|
|
788,137
|
|
|
|
724,834
|
|
Valuation allowance
|
|
|
―
|
|
|
|
―
|
|
Net deferred tax assets - current
|
|
|
788,137
|
|
|
|
724,834
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities - current
|
|
|
|
|
|
|
|
|
Revenue (net off cost)
|
|
|
63,545
|
|
|
|
37,202
|
|
Deferred tax liabilities - current
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets - current
|
|
|
724,593
|
|
|
|
687,632
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities - non-current
|
|
|
|
|
|
|
|
|
Land use right
|
|
|
310,153
|
|
|
|
291,995
|
|
Deferred tax liabilities - non-current
|
|
|
310,153
|
|
|
|
291,995
|
|
Deferred taxation is calculated
under the liability method in respect of taxation effect arising from all timing differences, which are expected with reasonable
probability to realize in the foreseeable future. The Company and its subsidiaries do not have income tax liabilities in U.S. as
the Company had no United States taxable income for the reporting period. The Company’s subsidiary registered in the PRC
is subject to income taxes within the PRC at the applicable tax rate.
NOTE M
–
ACCEPTANCE NOTES TO VENDORS
Bank acceptance notes to
vendors represent accounts payable in the form of bills of exchange whose acceptances are guaranteed and settlements are handled
by banks. From time to time we receive bank acceptance notes payable to the Company from our customers, for goods we sell to those
customers. If the notes are not yet due and payable, we may exchange them at a bank in exchange for notes payable to our suppliers,
and deliver those notes to our vendors. In such cases, we pay a small service fee to the banks. The bank acceptance notes usually
mature and are payable to vendors by the banks in six months. The Company does not have to pay any interest to the banks on these
notes. The vendors would pay interest if they discounted the bank acceptance notes to vendors at the banks.
Bank acceptance notes to
vendors
were both $0
as of each of March 31, 2013 and December 31, 2012.
NOTE N – SHORT-TERM BANK
LOANS
Bank loans represented
the following as of each of March 31, 2013 and December 31, 2012:
|
|
March 31,
2013
|
|
|
December 31,
2012
|
|
Secured
|
|
$
|
11,044,709
|
|
|
$
|
14,599,753
|
|
The Company obtained those
short term loans from Bank of China and Agricultural Bank of China, respectively, to finance general
working capital as well as new equipment acquisition. The Company did not provide any guarantee to any other parties. Interest
rate for the loans ranged from1.37% to 6.16% per annum. The maturity dates of the loans ranged from June 17, 2013 to July 27, 2013.
Corporate or personal guarantee:
|
$2.8 Million
|
Guaranteed by Ruili Group Co., Ltd., a related party;
|
$8.3 Million
|
Guaranteed by Ruili Group Co., Ltd., a related party, Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both principal shareholders.
|
NOTE O - ACCRUED EXPENSES
Accrued expenses consisted of the following
as of March 31, 2013 and December 31, 2012:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
Accrued payroll
|
|
$
|
1,366,738
|
|
|
$
|
1,484,082
|
|
Accrued warranty expenses
|
|
|
3,972,357
|
|
|
|
3,787,738
|
|
Other accrued expenses
|
|
|
3,778,290
|
|
|
|
3,229,999
|
|
Total accrued expenses
|
|
$
|
9,117,385
|
|
|
$
|
8,501,819
|
|
NOTE P –CAPITAL LEASE OBLIGATIONS
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
Total Capital Lease Obligations
|
|
$
|
13,792,184
|
|
|
$
|
10,458,352
|
|
|
|
|
|
|
|
|
|
|
Less: Current portion
|
|
$
|
(3,662,006
|
)
|
|
$
|
(10,458,352
|
)
|
Non-current portion
|
|
$
|
10,130,178
|
|
|
$
|
—
|
|
The 2012 capital lease obligation was under an agreement with International Far Eastern Leasing Co., Ltd.,
for a term of 60 months and an interest rate of 7.95% per annum, payable monthly in arrears. International Far Eastern Leasing
Co., Ltd. is the subsidiary of China Sinochem Corporation. To reduce the financing expense, the Company entered into a new leasing
agreement with International Far Eastern Leasing Co., Ltd. after communication with it in December 2012 and terminated the original
agreement. The duration of the new agreement is forty eight (48) months. The value of the leased equipment is RMB91, 428,571, with
a security deposit of RMB11, 428,571. The actual amount is RMB80,000,000. The Company prepaid all interests of RMB10, 705,357 after
the discount and has the lease payment of RMB1, 904,761.90 monthly. The prepaid capital lease interest will be amortized over the
life of capital lease agreement using the effective interest method.
NOTE Q – RESERVE
The reserve funds are comprised of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
Statutory surplus reserve fund
|
|
$
|
9,806,289
|
|
|
$
|
9,676,183
|
|
Total
|
|
$
|
9,806,289
|
|
|
$
|
9,676,183
|
|
Pursuant to the relevant
laws and regulations of Sino-foreign joint venture enterprises, the profits of the Company's subsidiaries, which are based on their
PRC statutory financial statements, are available for distribution in the form of cash dividends after they have satisfied all
the PRC tax liabilities, provided for losses in previous years, and made appropriations to reserve funds, as determined at the
discretion of the board of directors in accordance with PRC accounting standards and regulations.
As stipulated by the relevant
laws and regulations for enterprises operating in the PRC, Ruian is required to make annual appropriations to the statutory surplus
funds. In accordance with the relevant PRC regulations and the articles of association of the respective companies, Ruian is required
to allocate a certain percentage of its profits after taxation, as determined in accordance with PRC accounting standards applicable
to the Company, to the statutory surplus reserve until such reserve reaches 50% of the registered capital of the Company.
Net income as reported
in the US GAAP financial statements differs from that as reported in the PRC statutory financial statements. In accordance with
the relevant laws and regulations in the PRC, the profits available for distribution are based on the statutory financial statements.
If Ruian has foreign currency available after meeting its operational needs, Ruian may make its profit distributions in foreign
currency to the extent foreign currency is available. Otherwise, it is necessary to obtain approval and convert such distributions
at an authorized bank. The reserve fund consists of retained earnings which have been allocated to the statutory reserve fund.
NOTE R - INCOME TAXES
The Joint Venture is registered
in the PRC, and is therefore subject to state and local income taxes within the PRC at the applicable tax rate on the taxable income
as reported in the PRC statutory financial statements in accordance with relevant income tax laws.
Company increased its investment
in the Joint Venture as a result of its financing in December, 2006. In accordance with the Income Tax Law of the People's Republic
of China on Foreign-invested Enterprises and Foreign Enterprises, the Joint Venture is eligible for additional preferential tax
treatment. For the years 2007 and 2008, the Joint Venture entitled to an income tax exemption on all pre-tax income generated by
the company above its pre-tax income generated in the year 2006. Thereafter, the Joint Venture will enjoy a 50% exemption from
the effective income tax rate on any pre-tax income above its 2006 pre-tax income, to be recognized in the years 2009, 2010 and
2011. The above taxation exemption was superseded, because the Joint Venture has been awarded the Chinese government's "High-Tech
Enterprise" designation. The High-Tech Enterprise certificate is valid for three years and provides for a reduced tax rate
of 15% for years 2009 through 2011. In 2012 December, the Joint Venture passed the re-assessment by the government, based
on PRC income tax laws. As a result, the tax rate was 25% for the first three quarters of 2012. Accordingly, it was taxed, and will
be taxed at the 15% tax rate in 2013 and 2014.
The reconciliation of the
effective income tax rate of Ruian to the statutory income tax rate in the PRC for the first quarter of 2013 and 2012 is as follows:
|
|
Three months ended
March 31, 2013
|
|
|
Three months
ended March 31,
2012
|
|
|
|
|
|
|
|
|
US Statutory income tax rate
|
|
|
35.00
|
%
|
|
|
35.00
|
%
|
|
|
|
|
|
|
|
|
|
Valuation allowance recognized with respect to the loss in the US company
|
|
|
-35.00
|
%
|
|
|
-35.00
|
%
|
|
|
|
|
|
|
|
|
|
HK Statutory income tax rate
|
|
|
16.50
|
%
|
|
|
16.50
|
%
|
|
|
|
|
|
|
|
|
|
Valuation allowance recognized with respect to the loss in those HK company
|
|
|
-16.50
|
%
|
|
|
-16.50
|
%
|
|
|
|
|
|
|
|
|
|
China Statutory income tax rate
|
|
|
25.00
|
%
|
|
|
25.00
|
%
|
|
|
|
|
|
|
|
|
|
China Statutory income exemption
|
|
|
-10.00
|
%
|
|
|
0.00
|
%
|
|
|
|
|
|
|
|
|
|
Tax refund
|
|
|
―
|
|
|
|
―
|
|
Other items
|
|
|
-4.05
|
%
|
|
|
3.17
|
%
|
|
|
|
|
|
|
|
|
|
Effective tax rate
|
|
|
10.95
|
%
|
|
|
28.17
|
%
|
|
|
Three months
ended March 31,
2013
|
|
|
Three months ended
March 31, 2012
|
|
Computed income tax provision at the statutory rate
|
|
$
|
408,489
|
|
|
$
|
902,117
|
|
Tax exemption
|
|
|
(241,196
|
)
|
|
|
―
|
|
Tax refund
|
|
|
―
|
|
|
|
―
|
|
Deferred tax provision
|
|
|
(13,212
|
)
|
|
|
(68,104
|
)
|
|
|
|
|
|
|
|
|
|
Current period permanent differences and other reconciling items
|
|
|
14,773
|
|
|
|
184,643
|
|
Total income taxes
|
|
$
|
168,854
|
|
|
$
|
1,018,656
|
|
Income taxes are calculated
on a separate entity basis. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts
of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components
of the Company’s net deferred tax assets and liabilities are approximately as mentioned above at March 31, 2013. 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. In the three months
ended March 31, 2013
, there were no penalties and interest,
which generally are recorded in the general and administrative expenses or in the tax expenses.
The
provisions for income taxes for the three months ended March 31, 2013 and 2012, respectively, are summarized as follows:
|
|
Three months
ended March 31,
2013
|
|
|
Three months ended
March 31, 2012
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
182,065
|
|
|
$
|
1,086,760
|
|
Deferred
|
|
|
(13,212
|
)
|
|
|
(68,104
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
168,854
|
|
|
$
|
1,018,656
|
|
As of March 31, 2013 and
December 31, 2012, the Company has no unrecognized tax benefits.
NOTE S - Non-controlling interest in subsidiaries
Non-controlling interest
in subsidiaries represents a 10% non-controlling interest, owned by Ruili Group Co., Ltd., in Ruian, and a 40% non-controlling
interest, owned by the Company’s Joint Venture partners, in SIH. Net income attributable to non-controlling interests in
subsidiaries amounted to $
140,300
and $
263,889
for the three
months ended March 31, 2013 and 2012, respectively.
|
|
March 31, 2013
|
|
|
March 31, 2012
|
|
|
|
|
|
|
|
|
|
|
10% non-controlling interest in Ruian
|
|
$
|
144,562
|
|
|
$
|
258,946
|
|
|
|
|
|
|
|
|
|
|
40% non-controlling interest in SIH
|
|
$
|
(4,262
|
)
|
|
$
|
4,943
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
140,300
|
|
|
$
|
263,889
|
|
NOTE T – OPERATING LEASES
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 2007 to December 2011 for one of the apartment buildings
and from January 2007 to December 2012 for the other. In December 2011, a new lease agreement was signed for the lease of two apartment
buildings. The lease term is from January 2012 to December 2016.
In May 2009, Ruian entered
into a lease agreement with Ruili Group Co., Ltd. for the lease of a manufacturing plant. The lease term is from September 2009
to May 2017.
In August 2009, SIH entered
into a lease agreement with MGR for the lease of an office with a five-year lease term. The leasehold improvements are amortized
over the lease term.
In August 2010, a new
a lease agreement was signed between Ruian and Ruili Group Co., Ltd., under which Ruian leased 32,410 square meters manufacturing
plant for its new purchased passenger vehicles brake systems business. The lease term is from September 2009 to August 2020.
The lease expenses were
$451,948 and $313,838 for the three months ended March 31, 2013 and March 31, 2012, respectively.
Future minimum rental
payments for the years ending on December 31 are as follows:
|
|
2013
|
|
|
2014
|
|
|
2015
|
|
|
2016
|
|
|
Thereafter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Lease Commitments
|
|
$
|
1,365,268
|
|
|
$
|
1,820,358
|
|
|
$
|
1,820,358
|
|
|
$
|
1,820,358
|
|
|
$
|
10,922,145
|
|
NOTE U - ADVERTISING COSTS
Advertising
costs were $30,827 and $29,725 for the three months ended March 31, 2013 and
March 31, 2012
,
respectively.
NOTE V- RESEARCH AND DEVELOPMENT EXPENSE
Research
and development costs are expensed as incurred and were $1,390,464 and $
1,267,156
for the
three months ended March 31, 2013 and
March 31, 2012
, respectively.
NOTE W - WARRANTY CLAIMS
Warranty
claims were $430,533 and $
461,538
for the three months ended March 31, 2013 and
March
31, 2012
, respectively. Warranty claims are classified as accrued expenses on the balance sheet. The
movement of accrued warranty expenses for the three months ended March 31, 2013 was as follows:
Beginning balance at January 01, 2013
|
|
$
|
3,787,738
|
|
Aggregate reduction for payments made
|
|
|
430,533
|
|
Aggregate increase for new warranties issued during current period
|
|
|
245,914
|
|
Effect on changes in foreign exchange rate
|
|
|
―
|
|
Ending balance at March 31, 2013:
|
|
$
|
3,972,357
|
|
NOTE X – SEGMENT INFORMATION
The Company produces brake systems and other related components (“commercial vehicles brake systems,
etc.”) for different types of commercial vehicles. On August 31, 2010, the Company through Ruian, executed an Asset
Purchase Agreement to acquire, and purchased, a segment of the passenger vehicle auto parts business (passenger vehicles brake
systems) of Ruili Group Co., Ltd. As a result of this acquisition, the Company's product offerings were expanded to both commercial
and passenger vehicles' brake systems and other key safety-related auto parts.
The Company has two operating
segments: commercial vehicles brake systems, etc. and passenger vehicles brake systems, etc.
All of the Company’s
long-lived assets are located in the PRC and Hong Kong. The Company and its subsidiaries did not have long-lived assets in the
United States for the reporting periods.
|
|
Three Months Ended March 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
NET SALES TO EXTERNAL CUSTOMERS
|
|
|
|
|
|
|
|
|
Commercial vehicles brake systems
|
|
$
|
34,002,216
|
|
|
$
|
35,467,955
|
|
Passenger vehicles brake systems
|
|
|
7,315,944
|
|
|
|
9,130,286
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
41,318,160
|
|
|
$
|
44,598,241
|
|
INTERSEGMENT SALES
|
|
|
|
|
|
|
|
|
Commercial vehicles brake systems
|
|
$
|
—
|
|
|
$
|
—
|
|
Passenger vehicles brake systems
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Intersegment sales
|
|
$
|
—
|
|
|
$
|
—
|
|
GROSS PROFIT
|
|
|
|
|
|
|
|
|
Commercial vehicles brake systems
|
|
$
|
8,438,728
|
|
|
$
|
10,165,832
|
|
Passenger vehicles brake systems
|
|
|
2,738,153
|
|
|
|
2,050,465
|
|
All other
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
11,176,881
|
|
|
$
|
12,216,297
|
|
Selling and distribution expenses
|
|
|
3,361,557
|
|
|
|
3,170,902
|
|
General and administrative expenses
|
|
|
4,163,146
|
|
|
|
3,857,757
|
|
Research and development expenses
|
|
|
1,390,464
|
|
|
|
1,267,156
|
|
Financial Expenses
|
|
|
946,244
|
|
|
|
594,897
|
|
Income (loss) from operations
|
|
|
1,315,470
|
|
|
|
3,325,585
|
|
Other income (expense), net
|
|
|
227,063
|
|
|
|
290,949
|
|
Income (loss) before income tax expense (benefit)
|
|
$
|
1,542,533
|
|
|
$
|
3,616,534
|
|
CAPITAL EXPENDITURE
|
|
|
|
|
|
|
|
|
Commercial vehicles brake systems
|
|
$
|
794,830
|
|
|
$
|
314,476
|
|
Passenger vehicles brake systems
|
|
|
171,016
|
|
|
|
80,954
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
965,846
|
|
|
$
|
395,430
|
|
DEPRECIATION AND AMORTIZATION
|
|
|
|
|
|
|
|
|
Commercial vehicles brake systems
|
|
$
|
1,639,573
|
|
|
$
|
1,542,513
|
|
Passenger vehicles brake systems
|
|
|
352,772
|
|
|
|
397,079
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,992,345
|
|
|
$
|
1,939,592
|
|
|
|
March 31, 2013
|
|
|
December 31,
2012
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
|
|
|
|
|
|
|
Commercial vehicles brake systems
|
|
$
|
201,818,122
|
|
|
$
|
192,842,721
|
|
Passenger vehicles brake systems
|
|
|
43,423,349
|
|
|
|
50,718,264
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
245,241,471
|
|
|
$
|
243,560,985
|
|
|
|
March 31, 2013
|
|
|
December 31,
2012
|
|
|
|
|
|
|
|
|
LONG LIVED ASSETS
|
|
|
|
|
|
|
|
|
Commercial vehicles brake systems
|
|
$
|
53,213,108
|
|
|
$
|
50,662,641
|
|
Passenger vehicles brake systems
|
|
|
11,449,375
|
|
|
|
13,324,439
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
64,662,483
|
|
|
$
|
63,987,080
|
|
All of the Company’s long-lived assets
are located in the PRC and Hong Kong. The Company and its subsidiaries do not have long-lived assets in the United States for the
reporting periods.
NOTE Y – PURCHASE DISCOUNT
Purchase
discounts represent discounts received from vendors for purchasing raw materials. The Company did not receive any purchase discounts
during the three months ended March 31, 2013 and
March 31, 2012
.
NOTE Z – SHIPPING AND HANDLING COSTS
Shipping
and handling costs incurred by the Company are included in selling expenses in the accompanying consolidated statements of income.
Shipping and handling costs were
$731,435 and $1,115,315
for the three month ended March 31,
2013 and
March 31, 2012
, respectively.
NOTE AA – STOCK COMPENSATION PLAN
We had no stock-based compensation
expense during the three months ended March 31, 2013 and March 31, 2012, respectively. There were no employee stock options or
warrants outstanding as of March 31, 2013.
NOTE AB- COMMITMENTS AND CONTINGENCIES
(1) According
to the law of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the
land only through land use rights granted by the Chinese government. The Company purchased the land use rights from Ruili Group
for approximately $13.9 million on September 28, 2007. The Company has not yet obtained the land use right certificate.
(2) Information
regarding lease commitments is provided in Note T.
NOTE AC - OFF-BALANCE SHEET ARRANGEMENTS
At March 31, 2013, 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.
ITEM 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management’s
discussion and analysis of certain significant factors that have affected our financial position and operating results during the
periods included in the accompanying unaudited condensed consolidated financial statements, as well as information relating to
the plans of our current management. This quarterly report on Form 10-Q includes forward-looking statements. Any statements contained
in this report that are not statements of historical fact may be deemed to be forward-looking statements. Generally, the words
“believes,” “anticipates,” “may,” “will,” “should,” “expect,”
“intend,” “estimate,” “continue,” and similar expressions, or the negative thereof, or
comparable terminology, are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties,
including the matters set forth in this report or other reports or documents we file with the Securities and Exchange Commission
from time to time, which could cause actual results or outcomes to differ materially from those anticipated. Undue reliance should
not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to update these
forward-looking statements.
The following discussion
and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes
thereto and other financial information contained elsewhere in this Form 10-Q.
OVERVIEW
The Company manufactures
and distributes automotive brake systems and other key safety-related components to automotive original equipment manufacturers,
or OEMs, and the related aftermarket both in China and internationally for use primarily in different types of commercial vehicles,
such as trucks and buses, and in passenger vehicles. Management believes that it is the largest manufacturer of automotive brake
systems in China for commercial vehicles such as trucks and buses.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
For a summary of our accounting
policies and estimates, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical
Accounting Policies and Estimates” in our Annual Report on Form 10-K for the Year ended December 31, 2012.
See Note P to the
attached Unaudited Condensed Consolidated Financial Statements for the information regarding changes in taxation by the government
of China.
Results of Operations
Results of operations for the three months ended March
31, 2013 as compared to the three months ended March 31, 2012.
SALES
|
|
Three Months ended
|
|
|
Three Months ended
|
|
|
|
March 31, 2013
|
|
|
March 31, 2012
|
|
|
|
(U.S. dollars in
millions)
|
|
Commercial vehicle brake systems, etc.
|
|
$
|
34.0
|
|
|
|
82.3
|
%
|
|
$
|
35.5
|
|
|
|
79.6
|
%
|
Passenger vehicle brake systems, etc.
|
|
$
|
7.3
|
|
|
|
17.7
|
%
|
|
$
|
9.1
|
|
|
|
20.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
41.3
|
|
|
|
100
|
%
|
|
$
|
44.6
|
|
|
|
100
|
%
|
Sales were $41,318,160
and $44,598,241 for the three months ended March 31, 2013 and 2012, respectively, a decrease of $3.3 million or 7.4%. The decrease
was mainly due to the decreased sales to the China OEM and aftermarkets.
The
sales from commercial vehicle brake systems decreased by $1.5 million, or 4.2%, to $34.0 million for the
first quarter
of 2013, compared to $
35.5
million for the same period of 2012. Due to the slowdown of the commercial
vehicle market in the first quarter of 2013, the sales from the OEM market decreased, which impacted the sales of the commercial
vehicle brake systems.
Due
to the slowdown of the passenger vehicle market and the customer base adjustment made by management, the sales from passenger vehicle
brake systems decreased by $1.8 million or 19.8%, to $7.3 million for the
first quarter of 2013, compared to $9.1 million
for the same period of 2012.
A breakdown of net sales
revenue for these markets for the first quarter of the 2013 and 2012, respectively, is set forth below:
|
|
Three
Months
|
|
|
|
|
|
Three
Months
|
|
|
|
|
|
|
|
|
|
ended
|
|
|
Percent
|
|
|
ended
|
|
|
Percent
|
|
|
|
|
|
|
March 31,
2013
|
|
|
of
Total Sales
|
|
|
March 31,
2012
|
|
|
of
Total Sales
|
|
|
Percentage
Change
|
|
|
|
|
|
|
(U.S. dollars in million)
|
|
|
|
|
|
|
|
China OEM market
|
|
$
|
22.8
|
|
|
|
55.2
|
%
|
|
$
|
25.8
|
|
|
|
57.8
|
%
|
|
|
-11.6
|
%
|
China Aftermarket
|
|
$
|
9.2
|
|
|
|
22.3
|
%
|
|
$
|
9.8
|
|
|
|
22.0
|
%
|
|
|
-6.1
|
%
|
International market
|
|
$
|
9.3
|
|
|
|
22.5
|
%
|
|
$
|
9.0
|
|
|
|
20.2
|
%
|
|
|
3.3
|
%
|
Total
|
|
$
|
41.3
|
|
|
|
100.0
|
%
|
|
$
|
44.6
|
|
|
|
100.0
|
%
|
|
|
-7.4
|
%
|
Despite the overall growth of the output
and sales of all the automobiles in China, in the first quarter of 2013, the commercial vehicle production and sales was 1.014
million units and 1.001 million units, up 0.08% and down 1.72%, respectively, and the production of heavy duty truck decreased
by 10.87% compared to the first quarter of 2012. The decline of the overall sales of heavy-duty trucks in China in the first quarter
of 2013 could be attributed to the deceleration of the growth in capital investment, domestic consumption and international trade,
which resulted in the reduced demand for heavy-duty trucks in the construction of residential and commercial real estate development
projects, infrastructure projects, as well as highway transportation of goods.
SORL has begun making
sales for construction equipment and expanded its market share in the bus market, which partially offset the effects of these
declines. Our first-quarter OEM sales declined 11.6% from 2012’s first quarter, to $22.8 million.
Our sales to the Chinese
aftermarket decreased by $0.6 million or 6.1%, to $9.2 million for the first quarter of 2013, compared to $9.8 million for
the same period of 2012. The usage of heavy-duty trucks in the construction of real estate development projects and infrastructure
projects was reduced in China in the first quarter of 2013, which resulted in the reduced replacement of auto parts. We will continue
with our strategies to further optimize our sales network, to help further penetrate into new markets. Accelerated urbanization
and the Chinese government’s increased support for public transportation favor expansion in the bus aftermarket, which may
present an opportunity for us to increase our sales in that market
Our export sales increased
by $0.3 million or 3.3%, to $9.3 million for the first quarter of 2013, as compared to $9.0 million for the same period of
2012. A part of our strategy is to strengthen and expand our distribution networks to increase the awareness of our brand
overseas. The increase primarily resulted from the recovery of the global economy.
COST OF SALES AND GROSS PROFIT
Cost of sales for the three
months ended March 31, 2013 were $30,141,279, a decrease of $2.2 million, or 6.9% from $32,381,944 for the same period last year.
Since the decrease of our sales is larger than the decrease of our cost of sales, our gross profit decreased by 8.5% from $12,216,297
for the first quarter of 2012 to $11,176,881 for the first quarter of 2013.
Gross
margin decreased to 27.1% from 27.4% for the three months ended March 31, 2013 from the same period in 2012.
Gross margin
is being affected by rising labor expenses, the appreciation of the Chinese currency, and higher raw material prices. We intend
to focus in 2013 on increasing production efficiency, improving the technologies of products, and improving our product portfolio,
to help us to maintain or increase our gross profit margin.
Cost
of sales from commercial vehicle brake systems for the three months ended March 31, 2013 were $25.6 million, a decrease of $0.3
million, or 1.0% from $25.3 million for the same period last year. The gross profit from commercial vehicle brake systems decreased
by 17.0% from $10.2 million for the first quarter of 2012 to $8.4 million for the first quarter of 2013. Gross margin from commercial
vehicle brake systems decreased to 24.8% from 28.7% for the three months ended March 31, 2013 compared with 2012.
Gross
margin was affected by rising labor expenses, the appreciation of the Chinese currency, and higher raw material prices.
Cost
of sales from passenger vehicle brake systems for the three months ended March 31, 2013 were $4.6 million, a decrease of $2.5 million,
or 35.3%, from $7.1 million for the same period last year. The gross profit from passenger vehicle brake systems decreased by 33.5%
from $2.7 million for the first quarter of 2012 to $2.1 million for the first quarter of 2013. Gross margin from passenger vehicle
brake systems increased to 37.4% from 22.5% for the three months ended March 31, 2013 compared with 2012.
We intend to focus
in 2013 on increasing production efficiency, improving the technologies of products, and improving our product portfolio, to help
us to maintain or increase our gross profit margins.
SELLING AND DISTRIBUTION EXPENSES
Selling and distribution
expenses were $3,361,557 for the three months ended March 31, 2013, as compared to $3,170,902 for the same period of 2012, an increase
of $190,655 or 6.0%.
The increase was mainly
due to increased wages expense and packaging expenses. As a percentage of sales revenue, selling expenses increased to 8.1%
for the three months ended March 31, 2013, as compared to 7.1% for the same period in 2012.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative
expenses were $4,163,146 for the three months ended March 31, 2013, as compared to $3,857,757 for the same period of 2012, an increase
of $305,389 or 7.9%. The increase was mainly due to increases in labor expenses and other administrative expenses for marketing
of the business. Since our sales decreased but general and administrative expenses increased, as a percentage of sales revenue,
general and administrative expenses increased to 10.1% for the three months ended March 31, 2013, as compared to 8.7%
for the same period in 2012.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development
expenses include payroll, employee benefits, and other personnel-related expenses associated with product development. Research
and development expenses also include first-party development costs. For the three months ended March 31, 2013, research and development
expense was $1,390,464, as compared to $1,267,156 for the same period of 2012, an increase of $123,308.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense increased
to $1,992,345 for the three months ended March 31, 2013, compared with $1,939,592 for the same period of 2012, an increase of $52,753.
The increase in depreciation and amortization expense was primarily due to the increase of purchased production equipment.
FINANCIAL EXPENSES
Financial expense mainly
consists of interest expense, the financing expense associated with our capital lease transaction and currency exchange loss. The
financial expense for the three months ended March 31, 2013 increased by $351,347 to $946,244 from $594,897 for the same period
of 2012, which was mainly due to increased interest expense and currency exchange loss.
OTHER INCOME
Other income, primarily
consisting of income from the sales of scraps, was $295,140 for the three months ended March 31, 2013, as compared to $351,845
for the three months ended March 31, 2012, a decrease of $56,705.
The decrease was mainly due to a decrease
in sales of raw material scraps for the three months ended March 31, 2013.
INCOME TAX
The Joint Venture is registered
in the PRC, and is therefore subject to state and local income taxes within the PRC at the applicable tax rate on the taxable income
as reported in the PRC statutory financial The Joint Venture is registered in the PRC, and is therefore subject to state and local
income taxes within the PRC at the applicable tax rate on taxable income as reported in the PRC statutory financial statements
in accordance with relevant income tax laws.
The Company
increased its investment in the Joint Venture as a result of its financing in December, 2006. In accordance with the Income
Tax Law of the People's Republic of China on Foreign-invested Enterprises and Foreign Enterprises, the Joint Venture was
eligible for additional preferential tax treatment for the years 2007 and 2008. In those years, the Joint Venture was
entitled to an income tax exemption on all pre-tax income generated by the Company above its pre-tax income generated in
the year 2006. This tax exemption was superseded as a result of the Joint Venture having been awarded the Chinese
government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate is valid for three years
and provides for a reduced tax rate for years 2009 through 2011. In 2012 December, the Joint Venture passed the re-assessment
by the government, based on PRC income tax laws. So the tax rate was 25% for the first three quarters of 2012. Accordingly,
it continues to be, or will be, taxed at the 15% tax rate in 2013 and 2014.
Income tax expense was $168,854, or an 11.0% effective tax rate, for the three months ended March 31,
2013, as compared to $1,018,656, or a 28.2% effective tax rate, for the three months ended March 31, 2012. The main reason was
because the tax rate for the first quarter of 2012 was 25%, and it was 15% for the first quarter of 2013 due to renewal of the
"High-Tech Enterprise" not received until 2012 December.
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. Net income attributable to non-controlling interest in subsidiaries amounted to $140,300 and $263,889
for the three months ended March 31, 2013 and 2012, respectively.
NET INCOME ATTRIBUTABLE TO STOCKHOLDERS
The net income attributable
to stockholders for the three months ended March 31, 2013 decreased by $1.1 million, to $1,233,379 from $2,333,989 for the
three months ended March 31, 2012 due to the factors discussed above. Earnings per share (“EPS”), both basic and diluted,
for the three months ended March 31, 2013 and 2012, were $0.06 and $0.12 per share, respectively.
FINANCIAL CONDITION
Liquidity and Capital Resources
OPERATING
At March 31, 2013, the Company had cash and cash equivalents of $43,222,310, as compared to cash and cash equivalents of
$41,253,353 at December 31, 2012. The Company had working capital of $138,282,570 at March 31, 2013, as compared to working capital
of $123,953,956 at December 31, 2012, reflecting current ratios of 4.27 and 3.26:1, respectively.
Net cash generated from
operating activities was $
2,871,322 for three months ended March 31, 2013 compared with $4,319,504
of net cash generated from operating activities in the same period in 2012, a decrease of $1.4 million, primarily due to the
increased cash outflow resulted from the changes in bank acceptance notes from customers and inventories.
INVESTING - During the
three months ended March 31, 2013, the Company expended net cash of $965,846 in investing activities, mainly for acquisition
of new equipment. For the three months ended March 31, 2012, the Company utilized $395,430 in investing activities.
FINANCING -
During the three months ended March 31, 2013, the Company repaid bank loans and a capital lease in the aggregate amount
of $499,107. The cash used by financing activities was $5,320,769 for three months ended March 31, 2012.
The Company has taken a
number of steps to improve the management of its cash flow. We place more emphasis on collection of accounts receivable from our
customers. We maintain good relationships with local banks. We believe that our current cash and cash equivalents and anticipated
cash flow generated from operations and our bank lines of credit will be sufficient to finance our working capital requirements
for the foreseeable future.
CURRENCY RISK AND FINANCIAL
INSTRUMENTS - Although our reporting currency is U.S. dollar, the functional currency of Joint Venture is RMB. As a result, we
are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange
rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our Renminbi revenues, earnings
and assets, as expressed in our U.S. dollar, will decline. In recent years, the RMB has been appreciating against the U.S. dollar.
Assets and liabilities
of our operating subsidiaries are translated into U.S. dollars at the exchange rate at the balance sheet date. The equity accounts
are translated at historical exchange rate and their income and expenses items are translated using the average rate for the period.
Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. Oversea contracts are primarily
dominated by U.S. dollars. As a result of the RMB’s appreciation in value against U.S. dollars in the three months ended
March 31, 2013, the Company’s revenue declined. The Company plan to take measures to manage its exposure to foreign currency
exchange rate fluctuations, such as diversifying its customer basis overseas into different currency zones, and stipulating predetermined
foreign currency exchange rates for payments to be received under its export sales contracts.
As the Company’s
current outstanding debt obligations are primarily short-term in nature, with fixed interest rates, the Company does not have any
material risk from an increase in market interest rates. However, to the extent that the Company arranges new borrowings in the
future, an increase in market interest rate would cause a commensurate increase in the interest expense related to such borrowings.
OFF-BALANCE SHEET AGREEMENTS
At March 31, 2013 we do
not have any material commitments for capital expenditures or have any transactions, obligations or relationships that could be
considered off-balance sheet arrangements.
According to the law of
China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through
land use rights granted by the Chinese government. The Company purchased the land use rights from Ruili Group for approximately
$13.9 million on September 28, 2007. The company has been negotiating with the government for a reduction in or exemption from
the tax being sought by the government in connection with the transfer of the land use rights, and pending resolution of that issue,
we have deferred accrual or payment of the tax. Due to the lack of resolution of that issue, the land use right certificate has
not been issued to the Company. We plan to conclude negotiations with the government and to obtain the land use rights certificate
as soon as practicable.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
See the discussion in Item
2 above, “Liquidity and Capital Resources”.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures:
As of the end of the period
covered by this report, management, including our principal executive officer and principal financial officer, evaluated the effectiveness
of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934 (“Exchange Act”)). Based upon that evaluation, our principal executive officer and principal financial
officer concluded that the disclosure controls and procedures were effective in all material respects to ensure that information
required to be disclosed in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated
to our management to allow their timely decisions regarding required disclosure.
Changes in Internal Control over Financial
Reporting:
There were no changes in
the Company’s internal control over financial reporting during the three months ended March 31, 2013 that have materially
affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Not applicable.
ITEM 1A. RISK FACTORS.
Not applicable.
ITEM 2. UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS
31.1
|
|
Certification of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
|
|
|
|
31.2
|
|
Certification of Principal Accounting Officer pursuant to Rule 13a-14 and Rule 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended.
|
|
|
|
32
|
|
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1)
|
|
(1)
|
Previously furnished in accordance with Item 601(b) (32)
of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise
subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under
the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates
it by reference.
|
SIGNATURES
Pursuant to the requirements
of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Dated : May 15, 2013
|
SORL AUTO PARTS, INC.
|
|
|
|
By: /s/ Xiao Ping Zhang
|
|
Name: Xiao Ping Zhang
|
|
Title: Chief Executive Officer
|
|
|
|
By: /s/ Zong Yun Zhou
|
|
Name: Zong Yun Zhou
|
|
Title: Chief Financial Officer
(Principal Accounting Officer)
|