- Quarterly Report (10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended June 30, 2012

 

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

For the transition period from _________ to _________

 

Commission file number 000-11991

 

SORL AUTO PARTS, INC.

(Exact name of registrant as specified in its charter)

 

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

No. 1169 Yumeng Road

Ruian Economic Development District

Ruian City, Zhejiang Province

People’s Republic Of China

(Address of principal executive offices)

 

 

86-577-6581-7720

(Registrant’s telephone number)

 

 

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

Yes x No ¨

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

Yes   x                     No  ¨

 

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

Large Accelerated Filer ¨

Accelerated Filer ¨

Non-Accelerated Filer ¨

Smaller Reporting Company x

 

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

Yes ¨  No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

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

As of August 10, 2012 there were 19,304,921 shares of Common Stock outstanding

 

 

SORL AUTO PARTS, INC.

FORM 10-Q

For the Quarter Ended June 30, 2012

 

INDEX

 

		Page
PART I.	FINANCIAL INFORMATION (Unaudited)	1
Item 1.	Financial Statements:	1
	Condensed Consolidated Balance Sheets as of June 30, 2012 (Unaudited) and December 31, 2011	2
	Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited) for the Six Months Ended June 30, 2012 and 2011	3
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2012 and 2011	4
	Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) for the Six months ended June 30, 2012 and 2011	5
	Notes to the Condensed Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis or Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	28
PART II.	OTHER INFORMATION	29
Item 1.	Legal Proceedings.	29
Item 1A.	Risk Factors.	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	29
Item 3.	Defaults Upon Senior Securities.	29
Item 4.	Mine Safety Disclosures.	29
Item 5.	Other Information.	29
Item 6.	Exhibits	29
SIGNATURES		30

 

1

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2012 and December 31, 2011

 

		June 30, 2012				December 31, 2011
		(Unaudited)
Assets
Current Assets
Cash and Cash Equivalents		US$	21,349,583			US$	17,116,692
Accounts Receivable, Net of Provision			69,124,181				65,344,441
Bank acceptance notes from customers			11,691,305				17,980,145
Inventory			54,863,701				56,377,556
Prepayments			7,145,345				2,484,026
Other current assets			2,022,219				4,960,061
Deferred tax assets			792,496				605,539
Total Current Assets			166,988,830				164,868,460
Fixed Assets
Machinery			51,338,974				49,879,491
Molds			1,379,570				1,384,825
Office equipment			1,507,432				1,439,305
Vehicle			1,977,931				1,853,111
Building			8,854,995				8,888,723
Machinery held under capital lease			18,097,156				18,166,087
Construction in progress			153,336				1,503,200
Less: Accumulated Depreciation			(34,309,286	)			(30,905,671	)
Property, Plant and Equipment, Net			49,000,108				52,209,071
Leasehold Improvements in Progress			366,912				375,604
Land Use Rights, Net			14,870,156				15,111,078
Other Non-Current Assets
Intangible Assets			175,203				175,871
Less: Accumulated Amortization			(100,226	)			(92,237	)
Intangible Assets, Net			74,977				83,634
Security Deposits On Lease Agreement			1,872,757				1,879,890
Other assets			9,046				-
Total Other Non-Current Assets			1,956,780				1,963,524
Total Assets		US$	233,182,786			US$	234,527,737
Liabilities and Shareholders' Equity
Current Liabilities
Accounts Payable, including $50,495 and $524,148 due to related parties at June 30, 2012 and December 31, 2011, respectively.		US$	10,418,339			US$	10,772,396
Bank acceptance notes to vendors			3,320,211				5,589,678
Deposit Received from Customers			5,012,252				5,074,532
Short term bank loans			12,080,097				16,448,527
Income tax payable			1,240,240				273,781
Accrued Expenses			9,660,623				8,808,788
Current Portion Of Capital Lease Obligations			2,389,159				2,305,125
Other Current Liabilities, including $118,659 and $143,950 due to related parties at June 30, 2012 and December 31, 2011, respectively.			241,852				467,850
Total Current Liabilities			44,362,773				49,740,677
Non-Current Liabilities
Non-Current Portion Of Capital Lease Obligations			9,211,306				10,469,265
Deferred tax liabilities			263,192				236,385
Total Non-Current Liabilities			9,474,498				10,705,650
Total Liabilities		US$	53,837,271			US$	60,446,327
Stockholders' Equity
Preferred Stock - No Par Value; 1,000,000 authorized; none issued and outstanding as of June 30, 2012 and December 31, 2011			-				-
Common Stock - $0.002 Par Value; 50,000,000 authorized, 19,304,921 and 19,304,921 issued and outstanding as of June 30, 2012 and December 31, 2011			38,609				38,609
Additional Paid In Capital			42,199,014				42,199,014
Reserves			8,919,810				8,375,392
Accumulated other comprehensive income			21,359,374				21,910,957
Retained Earnings			89,395,858				84,610,260
Total SORL Auto Parts, Inc. stockholders' equity			161,912,665				157,134,232
Noncontrolling Interest In Subsidiaries			17,432,850				16,947,178
Total Equity			179,345,515				174,081,410
Total Liabilities and Stockholders' Equity		US$	233,182,786			US$	234,527,737

 

The accompanying notes are an integral part of these financial statements

 

2

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Income and Comprehensive Income

Three Months and Six Months Ended June 30, 2012 and 2011

 

		Three Month Ended June 30,								Six Months Ended June 30,
		2012				2011				2012				2011
Sales		US$	52,092,172				61,106,892				96,690,413				113,099,857
Include: sales to related parties			393,384				388,169				1,458,611				1,293,116
Cost of Sales			37,912,979				44,524,512				70,294,923				81,928,458
Gross Profit			14,179,193				16,582,380				26,395,490				31,171,399
Expenses:
Selling and Distribution Expenses			3,523,498				3,459,526				6,694,400				6,528,754
General and Administrative Expenses			3,493,009				3,813,274				7,350,766				6,679,722
Research and development expenses			2,296,820				2,198,707				3,563,976				4,177,608
Financial Expenses			532,722				872,846				1,127,619				1,440,198
Total Expenses			9,846,049				10,344,353				18,736,761				18,826,282
Operating Income			4,333,144				6,238,027				7,658,729				12,345,117
Other Income			412,975				259,109				764,820				464,357
Non-Operating Expenses			(192,296	)			(31,790	)			(253,192	)			(39,927	)
Income (Loss) Before Provision for Income Taxes			4,553,823				6,465,346				8,170,357				12,769,547
Provision for Income Taxes			1,279,762				973,077				2,298,418				1,922,820
Net Income		US$	3,274,061				5,492,269			US$	5,871,939				10,846,727
Other Comprehensive Income - Foreign Currency Translation Adjustment			(873,696	)			2,080,892				(607,834	)			3,615,068
Total Comprehensive Income			2,400,365				7,573,161				5,264,105				14,461,795
Less:
Net income attributable to Noncontrolling Interest In Subsidiaries			278,034				522,072				541,923				1,022,207
Other Comprehensive Income Attributable to Non-controlling Interest's Share			(86,950	)			208,209				(56,251	)			361,627
Total Comprehensive Income Attributable to Non-controlling Interest's Share			191,084				730,281				485,672				1,383,834
Net Income Attributable to Stockholders		US$	2,996,027				4,970,197				5,330,016				9,824,520
Other Comprehensive Income Attributable to Stockholders			(786,746	)			1,872,683				(551,583	)			3,253,441
Total Comprehensive Income Attributable to Stockholders		US$	2,209,281				6,842,880				4,778,433				13,077,961
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			0.16				0.26				0.28				0.51
EPS – Diluted		US$	0.16				0.26				0.28				0.51

 

The accompanying notes are an integral part of these financial statements

 

3

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Six Months Ended June 30, 2012 and 2011

 

		Six Months Ended June 30,
		2012				2011
Cash Flows from Operating Activities
Net Income		US$	5,330,016				9,824,519
Adjustments to reconcile net income (loss) to net cash from operating activities:
Noncontrolling Interest In Subsidiaries			541,923				1,022,207
Bad Debt Expense			27,775				578,855
Depreciation and Amortization			3,787,576				3,431,967
Loss on disposal of Fixed Assets			2,333				-
Changes in Assets and Liabilities:
Account Receivables			(3,517,570	)			(16,957,484	)
Bank acceptance notes from customers			6,248,483				12,686,597
Other Currents Assets			2,420,536				(952,670	)
Inventory			1,308,149				(9,270,332	)
Prepayments			(4,688,661	)			(645,702	)
Deferred tax assets			(189,870	)			(187,706	)
Accounts Payable and Bank acceptance notes to vendors			(2,587,357	)			12,203,405
Income Tax Payable			966,078				195,517
Deposits Received from Customers			(43,080	)			(2,752,132	)
Other Current Liabilities and Accrued Expenses			577,231				1,347,385
Deferred tax liabilities			27,798				26,746
Net Cash Flows from Operating Activities			10,211,360				10,551,172
Cash Flows from Investing Activities
Acquisition of Property and Equipment			(415,296	)			(4,855,872	)
Sales proceeds of disposal of fixed assets			3,096				-
Leasehold Improvements in Progress			(31,069	)			-
Net Cash Flows from Investing Activities			(443,269	)			(4,855,872	)
Cash Flows from Financing Activities
Proceeds from (Repayment of) Bank Loans			(4,325,512	)			1,532,234
Repayment of capital lease			(1,129,247	)			-
Net Cash flows from Financing Activities			(5,454,759	)			1,532,234
Effects on changes in foreign exchange rate			(80,441	)			261,553
Net Change in Cash and Cash Equivalents			4,232,891				7,489,087
Cash and Cash Equivalents- Beginning of the year			17,116,692				6,691,078
Cash and cash Equivalents - End of the period		US$	21,349,583				14,180,165
Supplemental Cash Flow Disclosures:
Interest Paid			690,117				1,319,871
Tax Paid			1,489,636				1,888,263

 

The accompanying notes are an integral part of these financial statements

 

4

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders' Equity

For The Six Months Ended on June 30, 2012 and 2011

 

										Additional								Retained				Accumu. Other
		Number				Common				Paid-in								Earnings				Comprehensive				Shareholders'				Noncontrolling				Total
		of Share				Stock				Capital				Reserves				(Deficit)				Income				Equity				Interest				Equity
Beginning Balance - January 1, 2012			19,304,921				38,609				42,199,014				8,375,392				84,610,260				21,910,957				157,134,232				16,947,178				174,081,410
Net Income																			5,330,016								5,330,016				541,923				5,871,939
Other Comprehensive Income(Loss)																							(551,583	)			(551,583	)			(56,251	)			(607,834	)
Transfer to reserve															544,418				(544,418	)							-				-				-
Ending Balance - June 30, 2012			19,304,921				38,609				42,199,014				8,919,810				89,395,858				21,359,374				161,912,665				17,432,850				179,345,515

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders' Equity

For The Six Months Ended on June 30, 2011

 

										Additional								Retained				Accumu. Other
		Number				Common				Paid-in								Earnings				Comprehensive				Shareholders'				Noncontrolling				Total
		of Shares				Stock				Capital				Reserves				(Deficit)				Income				Equity				Interest				Equity
Beginning Balance - January 1, 2011			19,304,921				38,609				42,199,014				6,641,547				69,672,286				14,731,607				133,283,063				14,517,162				147,800,225
Net Income																			9,824,520								9,824,520				1,022,207				10,846,727
Other Comprehensive Income(Loss)																							3,253,441				3,253,441				361,627				3,615,068
Transfer to reserve															994,830				(994,830	)							-				-				-
Ending Balance - June 30, 2011			19,304,921				38,609				42,199,014				7,636,377				78,501,976				17,985,048				146,361,024				15,900,996				162,262,020

 

The accompanying notes are an integral part of these financial statements

 

5

 

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE A - DESCRIPTION OF BUSINESS

 

SORL Auto Parts, Inc.( “the Company”) 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 Company Limited (“Ruian” or the “Joint Venture” ) in the People’s Republic of China (“PRC” or “China”) and 60% ownership of SORL International Holding, Ltd. ("SIH") in Hong Kong. The Company distributes products both in China and internationally under SORL trademarks. The Company’s products range in 65 categories and over 2000 different specifications.

 

NOTE B - BASIS OF PRESENTATION

 

The condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated in the consolidation. Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted as permitted by the rules and regulations of the United States Securities and Exchange Commission, although the Company believes that the disclosures contained in this report are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2011, and other reports filed with the SEC.

 

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

 

NOTE C- RECENTLY ISSUED FINANCIAL STANDARDS

 

In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASU 2011-04). This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (ASU 2011-05). This newly issued accounting standard: (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented.

 

6

 

In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers the requirement within ASU 2011-05 to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. During the deferral, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the issuance of ASU 2011-05. These ASUs are required to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. As these accounting standards do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income, the adoption of these standards did not have an impact on our consolidated financial statements.

 

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (ASU 2011-11). This newly issued accounting standard requires an entity to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on its financial position. This ASU is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. As this accounting standard only requires enhanced disclosure, the adoption of this standard is not expected to have an impact on our consolidated financial statements.

 

NOTE D - RELATED PARTY TRANSACTIONS

 

The Company continued to purchase packaging materials from the Ruili Group Co., Ltd. The Ruili Group Co., Ltd., is the minority shareholder of Ruian and is controlled by Mr. Xiao Ping Zhang and his family, who is the CEO and also the controlling party of the Company.

 

The following related party transactions are reported for the three months and six months ended June 30, 2012 and 2011:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2012				2011				2012				2011
PURCHASES FROM:
Ruili Group Co., Ltd.		$	1,517,619			$	2,237,782			$	2,582,846			$	3,634,917
Total Purchases		$	1,517,619				2,237,782			$	2,582,846				3,634,917
SALES TO:
Ruili Group Co., Ltd.		$	393,384			$	388,169			$	1,458,611			$	1,293,116
Total Sales		$	393,384			$	388,169			$	1,458,611			$	1,293,116

  

		June 30,				December 31,
		2012				2011
ACCOUNTS PAYABLE
Ruili Group Co., Ltd.		$	50,495			$	524,148
Total		$	50,495			$	524,148
OTHER PAYABLES
MGR Hong Kong Limited		$	39,499			$	25,559
Ruili Group Co., Ltd.			79,160				118,391
Total		$	118,659			$	143,950

 

7

 

NOTE E - ACCOUNTS RECEIVABLE

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the quarter ended June 30, 2012. The changes in the allowance for doubtful accounts at June 30, 2012 and December 31, 2011 are summarized as follows:

 

		June 30,				December 31,
		2012				2011
Beginning balance		$	892,455			$	319,687
Add: Increase to allowance			24,269				572,768
Less: Accounts written off			—				—
Ending balance		$	916,724			$	892,455

 

		June 30,				December 31,
		2012				2011
Accounts receivable		$	70,040,905			$	66,236,896
Less: allowance for doubtful accounts			(916,724	)			(892,455	)
Account receivable balance, net		$	69,124,181			$	65,344,441

 

NOTE F - INVENTORIES

 

On June 30, 2012 and December 31, 2011, inventories consisted of the following:

 

		June 30,				December 31,
		2012				2011
Raw Material		$	12,456,512			$	13,019,592
Work in process			11,504,158				16,576,415
Finished Goods			30,903,031				26,781,549
Total Inventory		$	54,863,701			$	56,377,556

 

8

 

NOTE G - PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following, on June 30, 2012 and December 31, 2011:

 

		June 30,				December 31,
		2012				2011
Machinery		$	51,338,974			$	49,879,491
Molds			1,379,570				1,384,825
Office equipment			1,507,432				1,439,305
Vehicle			1,977,931				1,853,111
Building			8,854,995				8,888,723
Machinery held under capital lease			18,097,156				18,166,087
Construction in progress			153,336				1,503,200
Sub-Total			83,309,394				83,114,742
Less: Accumulated depreciation			(34,309,286	)			(30,905,671	)
Fixed Assets, net		$	49,000,108			$	52,209,071

 

Depreciation expense charged to operations was $3,550,342 and $3,216,998 for the six months ended June 30, 2012 and 2011, respectively.

 

On September 13, 2011, the Company entered an agreement with International Far Eastern Leasing Co., Ltd.(a first party) and sold and simultaneously leased back part of its unencumbered manufacturing equipment, for a term of 60 months and an interest rate of 7.95%. The sale price of the manufacturing equipment was $13,209,492. As related to this transaction, the Company put down a security deposit of $1,863,916 to be refunded back to the Company after the end of the lease. In addition, the Company paid a fee of $641,484 to this first party accounted for as financing expense in the accompanying condensed consolidated financial statements. The Company has an option, exercisable at the end of the lease term, to repurchase the manufacturing equipment for $157. The transaction was accounted for as a financing transaction and was recorded in the accompanying condensed consolidated financial statements as a capital lease.

 

NOTE H- LEASEHOLD IMPROVEMENTS

 

		June 30,				December 31,
		2012				2011
Cost:		$	544,390			$	517,011
Less: Accumulated amortization:			(177,478	)			(141,407	)
Leasehold Improvements In Progress, net		$	366,912			$	375,604

 

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.

 

9

 

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 June 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

 

		June 30,				December 31,
		2012				2011
Cost:		$	16,614,187			$	16,677,470
Less: Accumulated amortization:			(1,744,031	)			(1,566,392	)
Land use rights, net		$	14,870,156			$	15,111,078

 

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 $184,203 and $172,068 for the six months ended June 30, 2012 and 2011, respectively.

 

NOTE J - INTANGIBLE ASSETS

 

Intangible assets owned by the Company included patent technology and management software licenses. Amortization expenses were $8,368 and $8,034 for the six months ended June 30, 2012 and 2011 respectively. Future estimated amortization expense is as follows:

 

2012				2013				2014				2015				2016				Thereafter
$	8,375			$	16,743			$	13,574			$	11,990			$	11,990			$	12,594

 

NOTE K - PREPAYMENT

 

Prepayment consisted of the following as of June 30, 2012 and December 31, 2011:

 

		June 30,				December 31,
		2012				2011
Raw material suppliers		$	5,603,255			$	1,773,877
Equipment purchase			1,542,090				710,149
Total prepayment		$	7,145,345			$	2,484,026

 

10

 

NOTE L - DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES

 

Deferred tax assets consisted of the following as of June 30, 2012 and December 31, 2011 comprise the following:

 

		June 30, 2012				December 31, 2011
Deferred tax assets - current
Provision			136,692				133,049
Revenue (net off cost)			11,040				―
Warranty			644,764				578,225
Deferred tax assets			792,496				711,274
Valuation allowance			―				―
Net deferred tax assets - current			792,496				711,274
Deferred tax liabilities - current
Revenue (net off cost)			―				105,735
Deferred tax liabilities - current			―				105,735
Net deferred tax assets - current			792,496				605,539
Deferred tax liabilities - non-current
Land use right			263,192				236,385
Deferred tax liabilities - non-current			263,192				236,385

 

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 $3,320,211 and $ 5,589,678 as of June 30, 2012 and December 31, 2011, respectively. The Company has pledged bank acceptance notes from customers of $3,320,211 to secure the bank acceptance notes to vendors granted by banks.

 

11

 

NOTE N - Bank Loans

 

Bank loans represented the following as of June 30, 2012 and December 31, 2011:

 

		June 30,				December 31,
		2012				2011
Secured		$	12,080,097			$	16,448,527
Less: Current portion		$	(12,080,097	)		$	(16,448,527	)
Non-current portion		$	—			$	—

 

The Company obtained those short-term loans from the Bank of China 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 from 5.89% to 7.38% per annum. The maturity dates of the loans ranged from July 16, 2012 to November 26, 2012.

 

Those short-term loans were guaranteed by Ruili Group Co., Ltd., a related party of the Company, of which Mr. Xiao Ping Zhang and Ms. Shu Ping Chi are both principal shareholders.

 

NOTE O - ACCRUED EXPENSES

 

Accrued expenses consisted of the following as of June 30, 2012 and December 31, 2011:

 

		June 30,				December 31,
		2012				2011
Accrued payroll		$	1,671,726			$	1,626,544
Accrued warranty expenses			4,298,427				3,854,832
Other accrued expenses			3,690,470				3,327,412
Total accrued expenses		$	9,660,623			$	8,808,788

 

NOTE P –CAPITAL LEASE OBLIGATIONS

 

		June 30,				December 31,
		2012				2011
Total Capital Lease Obligations		$	11,600,465			$	12,774,390
Less: Current portion		$	(2,389,159	)		$	(2,305,125	)
Non-current portion		$	9,211,306			$	10,469,265

 

The capital lease obligation was under the agreement with International Far Eastern Leasing Co., Ltd., which was disclosed in Note G, 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 (listed among the 2012 Fortune 500 company list by Fortune magazine). As related to this transaction, the Company made a security deposit of $1,879,890 to be refunded back to the Company after the end of the lease.

 

12

 

NOTE Q – RESERVE

 

The reserve funds are comprised of the following:

 

		June 30,				December 31,
		2012				2011
Statutory surplus reserve fund		$	8,919,810			$	8,375,392
Total		$	8,919,810			$	8,375,392

 

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

 

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

 

Net income as reported in 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

 

Ruian 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.

 

The Company increased its investment in Ruian 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, Ruian was eligible for additional preferential tax treatment. For the years 2007 and 2008, Ruian was entitled to an income tax exemption on all pre-tax income generated by the company above its pre-tax income generated in the fiscal year 2006. Thereafter, Ruian was entitled to a 50% exemption from the effective income tax rate on any pre-tax income above its 2006 pre-tax income, to be recognized in the years 2009, 2010 and 2011. The above taxation exemption was superseded, because Ruian 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. So, the Company’s effective income tax rate was 15% for years 2009 through 2011. For the quarter ended June 30, 2012, the effective income tax rate was 25%. However, the Company is in the process of renewing its “High-Tech Enterprise” certificate, a certificate awarded by the government of China for qualified enterprises with high and new technologies that are encouraged by the government. If this renewal is successful, according to the China Corporate Income Tax Law, which came into effect on January 1, 2008, the effective income tax rate for qualified high and new technology enterprises, such as the Company, may be reduced to 15% later in 2012.

 

13

 

The reconciliation of the effective income tax rate of Ruian to the statutory income tax rate in the PRC for the six months of 2012 and 2011 is as follows:

 

		Six months ended June 30, 2012				Six months ended June 30, 2011
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			0.00	%			-10.00	%
Tax refund			―				―
Other items			3.13	%			-0.18	%
Effective tax rate			28.13	%			14.82	%

  

		Six months ended June 30, 2012				Six months ended June 30, 2011
Computed income tax provision at the statutory rate		$	2,086,965			$	3,244,122
Tax exemption			―				(1,297,649	)
Deferred tax provision			(162,071	)			(160,960	)
Current period permanent differences and other reconciling items			373,524				137,307
Total income taxes		$	2,298,418			$	1,922,820

 

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 on June 30, 2012. 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 year of 2012, there were known penalties in the amount of $40,000 related to tax years 2007 and 2008, which the Company is in the process of settlement with the U.S. tax authority. The provisions for income taxes for the six months ended June 30, 2012 and 2011, respectively, are summarized as follows:

 

14

 

 

		Six months ended June 30, 2012				Six months ended June 30, 2011
Current		$	2,460,489			$	2,083,780
Deferred			(162,071	)			(160,960	)
Total		$	2,298,418			$	1,922,820

 

The Company adopted the provisions of FASB ASC 740-10 (Prior authoritative literature: FIN No. 48, Accounting for Uncertainty in Income Taxes) on January 1, 2007. As the result of the implementation of the FASB ASC 740-10, Accounting for Uncertainty in Income Taxes – In Interpretation of FASB ASC 740-10 (Prior authoritative literature: FASB Statement No. 109), the Company recognized no material adjustments to unrecognized tax benefits. On the adoption date of January 1, 2007 and as of June 30, 2012 and December 31, 2011, 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 $ 541,923 and $1,022,207 for the six months ended June 30, 2012 and 2011, respectively.

 

		June 30, 2012				June 30, 2011
10% non-controlling interest in Ruian		$	604,909			$	1,105,367
40% non-controlling interest in SIH		$	(62,986	)			(83,160	)
Total		$	541,923				1,022,207

 

NOTE T - 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 $635,562 and $535,787 for the six months ended June 30, 2012 and June 30, 2011, respectively.

 

Future minimum rental payments for the years ending December 31 are as follows:

 

		2012				2013				2014				2015				2016				Thereafter
Operating Lease Commitments		$	575,686			$	1,053,082			$	1,053,082			$	1,053,082			$	1,053,082			$	2,651,261

 

15

 

NOTE U - ADVERTISING COSTS

 

Advertising costs were $125,125 and $105,967 for the six months ended June 30, 2012 and 2011, respectively.

 

NOTE V - RESEARCH AND DEVELOPMENT EXPENSE

 

Research and development costs are expensed as incurred and were $3,563,976 and $4,177,608 for the six months ended June 30, 2012 and 2011, respectively.

 

NOTE W - WARRANTY CLAIMS

 

Warranty claims were $999,717 and $1,258,684 for the six months ended June 30, 2012 and 2011, 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, 2012 was as follows:

 

Beginning balance at January 01, 2012			3,854,832
Aggregate reduction for payments made			(540,244	)
Aggregate increase for new warranties issued during current period			999,717
Effect on changes in foreign exchange rate			(15,878	)
Ending balance at June 30, 2012:			4,298,427

 

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 do not have long-lived assets in the United States for the reporting periods.

 

16

 

		Six Months Ended June 30,
		2012				2011
NET SALES TO EXTERNAL CUSTOMERS
Commercial vehicles brake systems		$	75,401,096			$	89,269,809
Passenger vehicles brake systems			21,289,317				23,830,048
Net sales		$	96,690,413			$	113,099,857
INTERSEGMENT SALES
Commercial vehicles brake systems		$				$
Passenger vehicles brake systems			―				―
Intersegment sales		$	―			$	―
GROSS PROFIT
Commercial vehicles brake systems		$	21,068,947			$	24,792,936
Passenger vehicles brake systems			5,326,543				6,378,463
All other
Gross profit		$	26,395,490			$	31,171,399
Selling and distribution expenses			6,694,400				6,528,754
General and administrative expenses			7,350,766				6,679,722
Research and development expenses			3,563,976				4,177,608
Financial Expenses			1,127,619				1,440,198
Income (loss) from operations			7,658,729				12,345,117
Other income (expense), net			511,628				424,430
Income (loss) before income tax expense (benefit)		$	8,170,357			$	12,769,547
CAPITAL EXPENDITURE
Commercial vehicles brake systems		$	362,315			$	3,766,377
Passenger vehicles brake systems			80,954				1,089,495
Total		$	443,269			$	4,855,872
DEPRECIATION AND AMORTIZATION
Commercial vehicles brake systems		$	2,983,607			$	2,928,995
Passenger vehicles brake systems			803,969				502,972
Total		$	3,787,576			$	3,431,967

 

		June 30, 2012				December 31, 2011
TOTAL ASSETS
Commercial vehicles brake systems		$	181,840,547			$	185,276,912
Passenger vehicles brake systems			51,342,239				49,250,825
Total		$	233,182,786			$	234,527,737

 

17

 

		June 30, 2012				December 31, 2011
LONG LIVED ASSETS
Commercial vehicles brake systems		$	51,619,356			$	55,030,829
Passenger vehicles brake systems			14,574,600				14,628,448
Total		$	66,193,956			$	69,659,277

 

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 six months ended June 30, 2012 and 2011.

 

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 $2,286,100 and $2,286,605 for the six month ended June 30, 2012 and 2011, respectively.

 

NOTE AA – STOCK COMPENSATION PLAN

 

We had no stock-based compensation expense during the six months ended June 30, 2012 and 2011, respectively. There were no employee stock options or warrants outstanding as of June 30, 2012.

 

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

 

On June 30, 2012, 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.

 

NOTE AD – THE ACQUISITION AND COMBINATION OF OPERATIONS REPORTING

 

All of the allocations and estimates in the Consolidated Financial Statements are based on assumptions that management believes are reasonable under the circumstances. However, these allocations and estimates are not necessarily indicative of the costs and expenses that would have resulted if the business we acquired from the Seller had been operated as a part of the Company for periods prior to the combination/acquisition.

  

18

  

NOTE AE – SUBSEQUENT EVENTS

 

The Company has no significant subsequent events from June 30, 2012 through the consolidated financial statements issue date of this report.

 

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

 

The following is management’s discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying unaudited condensed consolidated financial statements, as well as information relating to the plans of our current management. This quarterly report on Form 10-Q includes forward-looking statements. Any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Generally, the words “believes,” “anticipates,” “may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar expressions, or the negative thereof, or comparable terminology, are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including the matters set forth in this report or other reports or documents we file with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those anticipated. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to update these forward-looking statements.

 

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

 

OVERVIEW

 

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

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

For a summary of our accounting policies and estimates, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the Fiscal Year ended December 31, 2011.

 

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

 

19

 

Results of Operations

 

Results of operations for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011.

SALES

 

		Three Months ended  30-Jun-12								Three Months ended 30-Jun-11
		(U.S.  dollars in millions)
Commercial vehicle brake systems, etc.		$	39.9				76.6	%		$	48.1				78.9	%
Passenger vehicle brake systems, etc.		$	12.2				23.4	%		$	12.9				21.1	%
Total		$	52.1				100.0	%		$	61.0				100.0	%

 

Net sales were $52,092,172 and $61,106,892 for the three months ended June 30, 2012 and 2011, respectively, a decrease of $9.0 million or 14.8%.

 

The sales from commercial vehicle brake systems decreased by $8.2 million or 17.0%, to $39.9 million for the second quarter of 2012, compared to $48.1 million for the same period of 2011. Due to the slowdown of the commercial vehicle market in the second quarter of 2012, the sales from the OEM market decreased, which impacted the sales of the commercial vehicle brake systems.

 

The sales from passenger vehicle brake systems decreased by $0.7 million or 5.4%, to $12.2 million for the second quarter of 2012, compared to $12.9 million for the same period of 2011.

 

A breakdown of net sales revenue for these markets for the second quarter of the 2012 and 2011 fiscal years, respectively, is set forth below:

  

		Three Months				Percent				Three Months				Percent
		ended				of				ended				of				Percentage
		30-Jun-12				Total Sales				30-Jun-11				Total Sales				Change
		(U.S. dollars in million)
China OEM market		$	25.6				49.1	%		$	32.6				53.4	%			-21.5	%
China Aftermarket		$	11.7				22.5	%		$	12.7				20.8	%			-7.9	%
International market		$	14.8				28.4	%		$	15.7				25.8	%			-5.7	%
Total		$	52.1				100.0	%		$	61.0				100.0	%			-14.6	%

 

Chinese domestic economic policies and regulations resulted in a low-growth environment for the automotive industry in the first half of 2012, which caused the growth rate in vehicle sales decline from the comparable period of 2011. For the first time in China’s industrialization and urbanization process, the growth rate of automotive vehicle sales declined over the first six month periods in two consecutive years, 2011 and 2012. However, this low-growth development is also partially a result of the significant increases in vehicle sales experienced in 2009 and 2010, and it is guiding the automotive industry to develop at a more rational long-term rate. To prevent sales to the OEM market from deteriorating, the Company enhanced its product line with a broader range of products through innovative new products as well as penetrating new market segments, such as the bus and the light-duty vehicle markets. As a result, our sales to the Chinese OEM market decreased by $7.0 million or 21.5%, to $25.6 million for the second quarter of 2012, compared to $32.6 million for the three month period ended June 30 of 2011.

 

20

 

Our sales to the Chinese aftermarket decreased by $1.0 million or 7.9%, to $11.7 million for the second quarter of 2012, compared to $12.7 million for the same period of 2011 due to overall slowdown in the auto parts market in China. The increased number of new vehicle sales in China and the expiration of OEM warranties helped drive our aftermarket business. Sales of our new model products, applicable to both OEM and aftermarket, also grew during the three months ended June 30, 2012. We will continue with our strategies to further optimize our sales network and 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.

 

Our export sales decreased by $0.9 million or 5.7%, to $14.8 million for the second quarter of 2012, as compared to $15.7 million for the same period of 2011. The debt crisis in Europe and the currency depreciation in some countries caused some of our customers to reduce their inventories; also the instability of the situation in the Middle Eastern countries restricted the purchases of our customers from us. We will take the following measures to ensure future growth in the international market:

(1) Enhance the Company brand image through industry exhibitions.

(2) Maintenance of our customer base and market position while penetrating new markets and capturing new customers.

(3) Building a stronger international marketing network with the focus on exploring high-value foreign markets, and active marketing to the large automotive chain stores that directly sell to end users.

(4) Further targeting the international OEM market by actively supporting initiatives that promote our overseas sales.

 

COST OF SALES AND GROSS PROFIT

 

Cost of sales for the three months ended June 30, 2012 were $37,912,979 a decrease of $6,611,533 or 14.8% from $44,524,512 for the three month period ended June 30, 2011. Our gross profit decreased by 14.5% from $16,582,380 for the period of 2011 to $14,179,193 for the three month period ended June 30, 2012.

 

Gross margin increased to 27.2% from 27.1% for the three months ended June 30, 2012 compared with 2011. 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 2012 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, 2012 were $29.0 million, a decrease of $5.1 million or 15.0% from $34.1 million for the same period last year. The gross profit from commercial vehicle brake systems decreased by 22.6% from $14.1 million for three month period ended June 30, 2011 to $10.9 million for the three month period ended June 30, 2012. Gross margin from commercial vehicle brake systems decreased to 27.3% from 29.2% for the three months period ended June 30, 2012 compared to the three month period ended June 30, 2011. The decrease was mainly due to raising labor expenses, the appreciation of the Chinese currency, and higher raw material prices.

 

21

 

 

Cost of sales from passenger vehicle brake systems for the three months period ended June 30, 2012 were $8.9 million, a decrease of $1.5 million or 14.5% from $10.4 million for the three month period ended June 30, 2011. The gross profit from passenger vehicle brake systems increased by 32.0% from $2.5 million for the three month period ended June 30, 2011 to $3.3 million for the three month period ended June 30, 2012. Gross margin from passenger vehicle brake systems increased to 26.9% from 19.4% for the three months ended June 30, 2012, as compared with 2011. The cost decrease was mainly due to the increase of production efficiency, the improvement of the technologies of products, and the improvement of our product portfolio. Such decrease in cost helps us to maintain or increase our gross profit margins.

 

SELLING AND DISTRIBUTION EXPENSES

 

Selling and distribution expenses were $3,523,498 for the three months ended June 30, 2012, as compared to $3,459,526 for the three month period ended June 30, 2011, an increase of $63,972 or 1.8%.

 

The increase was mainly due to increased wages expense and travel expenses. As a percentage of sales revenue, selling expenses increased to 6.8% for the three months ended June 30, 2012, as compared to 5.7% for the three month period ended June 30, 2011.

 

GENERAL AND ADMINISTRATIVE EXPENSES

 

General and administrative expenses were $3,493,009 for the three months period ended June 30, 2012, as compared to $3,813,274 for the three month period ended June 30, 2011, a decrease of $320,265 or 8.4%. The general and administrative expenses decreased as a result of decreased sales. The Company incurred fewer expenses in relation to reduced sales. As a percentage of sales revenue, general and administrative expenses increased to 6.7% for the three months period ended June 30, 2012, as compared to 6.2% for the three month period ended June 30, 2011.

 

RESEARCH AND DEVELOPMENT EXPENSE

 

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 period ended June 30, 2012, research and development expense was $2,296,820, as compared to $2,198,707 for the three month period ended June 30, 2011, an increase of $98,113.

 

DEPRECIATION AND AMORTIZATION

 

Depreciation and amortization expense increased to $1,847,984 for the three months period ended June 30, 2012, compared with that of $1,743,079 for the three month period ended June 30, 2011, an increase of $104,905. The increase in depreciation and amortization expense was primarily due to the addition of purchased production equipment.

 

FINANCIAL EXPENSE

 

Financial expense mainly consists of interest expense, the financing expense associated with our capital lease transaction and exchange loss. The financial expense for the three months period ended June 30, 2012, decreased by $340,124 to $532,722 from $872,846 for the three month period ended June 30, 2011, which was primarily due to lower interest rate.

 

OTHER INCOME

 

Other income was $412,975 for the three months period ended June 30, 2012, as compared to $259,109 for the three months period ended June 30, 2011, an increase of $153,866. The increase was mainly due to an increase in sales of raw material scrap for the three months period ended June 30, 2012.

 

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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 fiscal 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 was valid for three years and provided for a reduced tax rate for years 2009 through 2011. Thus, our effective income tax rate was 15% for years 2009 through 2011. For the three-month ended June 30, 2012, the effective income tax rate was 25%. However, the Company is in the process of renewing its “High-Tech Enterprise” certificate. If this renewal is successful, the effective income tax rate may be reduced to 15% later in 2012.

 

Income tax expense of $1,279,762 and $973,077 was recorded for the quarters ended June 30, 2012 and 2011, respectively.  

 

STOCK-BASED COMPENSATION

 

There were no options or warrants outstanding as of June 30, 2012.

 

Although the Company anticipates that future issuances of stock awards could have a material impact on reported net income in future financial statements, we do not expect them to have a material impact on future cash flows.

 

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 $278,034 and $522,072 for the second quarter ended June 30, 2012 and 2011, respectively.

 

NET INCOME ATTRIBUTABLE TO STOCKHOLDERS

 

The net income attributable to stockholders for the three-month period ended June 30, 2012, decreased by $1,974,170, to $2,996,027 from $4,970,197 for the three-month period ended June 30, 2011 due to the factors discussed above. Earnings per share (“EPS”), both basic and diluted, for the quarter ended June 30, 2012 and 2011, were $0.16 and $0.26 per share, respectively.

 

 

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Results of operations for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011.

 

SALES

 

		Six months ended  30-Jun-12								Six months ended  30-Jun-11
		(U.S.  dollars in millions)
Commercial vehicles brake systems, etc.		$	75.4				78.0	%		$	89.2				78.9	%
Passenger vehicles brake systems, etc.		$	21.3				22.0	%		$	23.8				21.1	%
Total		$	96.7				100.0	%		$	113.0				100.0	%

 

Net sales were $96,690,413 and $113,099,857 for the six months ended June 30, 2012 and 2011, respectively, a decrease of $16,409,444 million or 14.5%.

 

The sales from commercial vehicle brake systems decreased by $13.8 million or 15.5%, to $75.4 million for the six month period ended June 30, 2012, compared to $89.2 million for the same period of 2011. Due to the slowdown of the commercial vehicle market in the six month period ended June 30, 2012, the sales from the OEM market decreased, which impacted the sales of the commercial vehicle brake systems.

 

The sales from passenger vehicle brake systems decreased by $2.5 million, or 10.5%, to $21.3 million for the six month period ended June 30, 2012, compared to $23.8 million for the six month period ended June 30, 2011.

 

A breakdown of net sales revenues for China OEM markets, China Aftermarket and International markets for the six months ended June 30, 2012 and 2011 fiscal years, respectively, is set forth below:

 

		Six months				Percent				Six months				Percent				Percentage
		ended				of				ended				of				Change
		30-Jun-12				Total Sales				30-Jun-11				Total Sales
		(U.S. dollars in million)
China OEM market		$	51.4				53.2	%		$	64.6				57.2	%			-20.4	%
China Aftermarket		$	21.5				22.2	%		$	21.3				18.8	%			0.9	%
International market		$	23.8				24.6	%		$	27.1				24.1	%			-12.2	%
Total		$	96.7				100.0	%		$	113.0				100.0	%			-14.4	%

 

Chinese domestic economic policies and regulations resulted in a low-growth environment for the automotive industry in the first half of 2012, which caused the growth rate in vehicle sales to decline from the comparable period of 2011. For the first time in China’s industrialization and urbanization process, the growth rate of automotive vehicle sales declined over the first six month periods in two consecutive years, 2011 and 2012. However, this low-growth development is also partially a result of the significant increases in vehicle sales experienced in the 2009 and 2010 years, and it is guiding the automotive industry to develop at a more rational long-term rate. To prevent sales to the OEM market from deteriorating further, the Company enhanced its product line with a broader range of products through innovative new products as well as penetrating new market segments such as the bus and the light-duty vehicle markets. As a result, our sales to the Chinese OEM market decreased by $13.2 million or 20.4%, to $51.4 million for the first half year of 2012, compared to $64.6 million for the three-month period ended June 30, 2011.

 

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Our sales to the Chinese aftermarket increased by $0.2 million or 0.9%, to $21.5 million for the first half year of 2012, compared to $21.3 million for the first half year of 2011. The increased number of new vehicle sales in China and the expiration of OEM warranties helped drive the increase in our aftermarket business. Sales of our new model products, applicable to both OEM and aftermarket, also grew during the six months ended June 30, 2012. We will continue with our strategies to further optimize our sales network and 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.

 

Our export sales decreased by $3.3 million or 12.2%, to $23.8 million for the six months of 2012, as compared to $27.1 million for the three month period ended June 30, 2011. The debt crisis in Europe and the currency depreciation in some countries caused some of our customers to reduce their inventories. Moreover, the instability of the political situation in the Middle Eastern countries restricted the purchases of our customers from us. We will take the following measures to ensure future growth in the international market:

 

(1) Enhance the Company brand image through industry exhibitions;

(2) Maintain our customer base and market position while penetrating new markets and capturing new customers;

(3) Build a stronger international marketing network with the focus on exploring high-value foreign markets, and actively market to the large automotive chain stores that directly sell to end users, and

(4) Further target the international OEM market by actively support initiatives that promote our overseas sales.

 

COST OF SALES AND GROSS PROFIT

 

Cost of sales for the six months period ended June 30, 2012 were $70,294,923, a decrease of $11,633,535 or 14.2% from $81,928,458 for the six months period ended June 30, 2011. Our gross profit decreased by 15.3% from $31,171,399 for the six months period ended June 30, 2011 to $26,395,490 for the same period of 2012.

 

Gross margin decreased to 27.3% from 27.6% for the six months period ended June 30, 2012, as compared with the six months period ended June 30, 2011. 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 2012 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 six months period ended June 30, 2012 were $54.3 million, a decrease of $10.2 million or 15.8% from $64.5 million for the six months period ended June 30, 2011. The gross profit from commercial vehicle brake systems decreased by 15.0% from $24.8 million for the six months period ended June 30, 2011 to $21.1 for the six months period ended June 30, 2012. Gross margin from commercial vehicle brake systems increased to 27.9% from 27.8% for the six months period ended June 30, 2012 compared with the same period of 2011. The increase is being affected by increasing production efficiency, improving the technologies of products, and improving our product portfolio.

 

Cost of sales from passenger vehicle brake systems for the six months period ended June 30, 2012 were $16.0 million, a decrease of $1.4 million or 8.0% from $17.4 million for the six months period ended June 30, 2011. The gross profit from passenger vehicle brake systems decreased by 17.2% from $6.4 for the six months period ended June 30, 2011 to $5.3 for the six months period ended June 30, 2012. Gross margin from passenger vehicle brake systems decreased to 25.0% from 26.8% for the six months period ended June 30, 2012, as compared with the six months period ended June 30, 2011. The cost decrease was mainly due to raising labor expenses, the appreciation of the Chinese currency, and higher raw material prices.

 

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SELLING AND DISTRIBUTION EXPENSES

 

Selling and distribution expenses were $6,694,400 for the six months ended June 30, 2012, as compared to $6,528,754 for the same period of 2011, an increase of $165,646 or 2.5%.

 

The increase was mainly due to increased wages expense and travel expenses. As a percentage of sales revenue, selling expenses increased to 6.9% for the six months ended June 30, 2012, as compared to 5.8% for the same period in 2011.

 

GENERAL AND ADMINISTRATIVE EXPENSES

 

General and administrative expenses were $7,350,766 for the six months ended June 30, 2012, as compared to $6,679,722 for the same period of 2011, an increase of $671,044 or 10.0%.

 

The increase was mainly due to increases in labor expenses and expenses for business expansion. As a percentage of sales revenue, general and administrative expenses increased to 7.6% for the six months ended June 30, 2012, as compared to 5.9% for the same period in 2011.

 

RESEARCH AND DEVELOPMENT EXPENSE

 

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 six months ended June 30, 2012, research and development expenses were $3,563,976, as compared to $4,177,608 for the same period of 2011, a decrease of $613,632.

 

DEPRECIATION AND AMORTIZATION

 

Depreciation and amortization expenses increased to $3,787,576 for the six months ended June 30, 2012, compared with that of $3,431,967 for the same period of 2011, an increase of $355,609. The increase in depreciation and amortization expenses was primarily due to the purchase of production equipment.

 

FINANCIAL EXPENSE

 

Financial expense mainly consists of interest expenses and exchange losses. The financial expense for the six months ended June 30, 2012, decreased by $312,579 to $1,127,619 from $1,440,198 for the same period of 2011, which was mainly due to lower interest rate.

 

OTHER INCOME

 

Other income was $764,820 for the six months ended June 30, 2012, as compared to $464,357 for the six months ended June 30, 2011, an increase of $300,463. The increase was mainly due to an increase in sales of raw material scrap for the six months ended June 30, 2012.

 

INCOME TAX

 

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

 

26

 

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 fiscal year 2006. This tax exemption was superseded as a result of the Chinese government awarded "High-Tech Enterprise" designation to the Joint Venture. The High-Tech Enterprise certificate is valid for three years and it provides the Joint Venture a reduced tax rate of 15% for years 2009 through 2011. Thus, our effective income tax rate is 15% for years 2009 through 2011. For the six months ended June 30, 2012, the effective income tax rate is 25%. However, the Company is in the process of renewing its “High-Tech Enterprise” certificate. If this renewal is successful, the effective income tax rate may be reduced to 15% in later 2012.

 

Income tax expenses of $2,298,418 and $1,922,820 were recorded for the six months ended June 30, 2012 and 2011, respectively.  

 

STOCK-BASED COMPENSATION

 

There were no options or warrants outstanding as of June 30, 2012.

 

Although the Company anticipates that future issuances of stock awards could have a material impact on reported net income in future financial statements, we do not expect them to have a material impact on future cash flows.

 

NET INCOME ATTRIBUTABLE TO NON-CONTROLLING INTEREST IN SUBSIDIARIES

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH. Each of the non-controlling interest is held by our Joint Venture partners. Net income attributable to non-controlling interest in subsidiaries amounted to $541,923 and $1,022,207 for the six months ended June 30, 2012 and 2011, respectively.

 

NET INCOME ATTRIBUTABLE TO STOCKHOLDERS

 

The net income attributable to stockholders for the six months period ended June 30, 2012, decreased by $4,494,504, to $5,330,016 from $9,824,520 for the six months ended June 30, 2011 due to the factors discussed above. Earnings per share, both basic and diluted, for the six months ended June 30, 2012 and 2011, were $0.28 and $0.51 per share, respectively.

 

FINANCIAL CONDITION

 

Liquidity and Capital Resources

OPERATING - Net cash provided by operating activities was $10,211,360 for the six months period ended June 30, 2012, a decrease of $339,812, as compared with $10,551,172 of net cash provided in operating activities in the same period in 2011 Such decrease was primarily due to increased cash inflow resulting from changes in accounts receivable which was offset by changes in accounts payable and bank acceptance notes to vendors. Most accounts receivable of our OEM customers were converted into bank acceptance notes from customers during the six months ended June 30, 2011.

 

At June 30, 2012, the Company had cash and cash equivalents of $21,349,583, as compared to cash and cash equivalents of $17,116,692 at December 31, 2011. The Company had working capital of $122,626,057 at June 30, 2012, as compared to working capital of $115,127,783 at December 31, 2011.

 

INVESTING - During the six months period ended June 30, 2012, the Company expended net cash of $443,269 in investing activities. For the six months period ended June 30, 2011, the Company utilized $4,855,872 in investing activities, mainly for acquisition of new equipment to support the growth of the business.

 

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FINANCING - During the six month period ended June 30, 2012, the Company repaid bank loans and a capital lease in the aggregate amount of $5,454,759. Net cash provided by financing activities was $1,532,234 for the six months ended June 30, 2011.

 

Management has taken a number of steps to restructure the Company’s customer base and phase out accounts which failed to make prompt payments. We also placed more emphasis on collection of accounts receivable from our customers. During 2012, to develop new products that we believe will have a higher profit margin, and adopting steps for further cost saving such as improving the material utilization rate. We maintain good relationships with local banks. We believe that our current cash, cash equivalents, anticipated cash flow generated from operations and our bank lines of credit will be sufficient to finance our working capital requirements for the foreseeable future.

 

CURRENCY RISK AND FINANCIAL INSTRUMENTS - Although our reporting currency is the U.S. dollar, the functional currency of Joint Venture is RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our Renminbi revenues, earnings and assets as expressed in our U.S. dollar financial statements 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, their 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. The Company is adopting such steps as the diversification of currencies used in export sales, and the negotiation of export contracts with fixed exchange rates.

 

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

 

OFF-BALANCE SHEET AGREEMENTS

 

On June 30, 2012 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 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:

 

28

 

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 quarter ended June 30, 2012 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.

 

None.

 

ITEM 1A. RISK FACTORS.

 

None.

 

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

 

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

  

(1)

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

 

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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, 2012	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 Financial Officer)

 

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