CAAS China Automotive Systems Inc

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

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

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

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

China Automotive Systems, Inc. and Subsidiaries

Condensed Unaudited Consolidated Statements of Cash Flows (continued)

(In thousands of USD unless otherwise indicated)

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

China Automotive Systems, Inc. and Subsidiaries

Notes to Condensed Unaudited Consolidated Financial Statements

Three Months and Nine Months Ended September 30, 2016 and 2015

China Automotive Systems, Inc., “China Automotive,” was incorporated in the State of Delaware on June 29, 1999 under the name Visions-In-Glass, Inc. China Automotive, including, when the context so requires, its subsidiaries and the joint ventures described below, is referred to herein as the “Company.” The Company is primarily engaged in the manufacture and sale of automotive systems and components, as described below.

Great Genesis Holdings Limited, a company incorporated in Hong Kong on January 3, 2003 under the Companies Ordinance in Hong Kong as a limited liability company, “Genesis,” is a wholly-owned subsidiary of the Company. Great Genesis is mainly engaged in the manufacture and sale of automotive systems and components through its controlled subsidiaries and the joint ventures, as described below.

Henglong USA Corporation, “HLUSA,” incorporated on January 8, 2007 in Troy, Michigan, is a wholly-owned subsidiary of the Company, and is mainly engaged in marketing of automotive parts in North America, and provides after-sales service and research and development support accordingly.

The Company owns the following aggregate net interests in the entities established in the People's Republic of China, the “PRC,” and Brazil as of September 30, 2016 and December 31, 2015.

Basis of Presentation – The accompanying condensed unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. The details of subsidiaries are disclosed in Note 1. Significant inter-company balances and transactions have been eliminated upon consolidation. The condensed unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions in Article 10 of Regulation S-X. Accordingly they do not include all of the information and footnotes required by such accounting principles for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

The accompanying interim condensed consolidated financial statements are unaudited, but in the opinion of the Company’s management, contain all necessary adjustments, which include normal recurring adjustments, for a fair statement of the results of operations, financial position and cash flows for the interim periods presented.

The condensed consolidated balance sheet as of December 31, 2015 is derived from the Company’s audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although the Company’s management believes that the disclosures contained in these financial statements are adequate to make the information presented herein not misleading. For further information, please refer to the financial statements and the notes thereto included in the Company’s 2015 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.

The results of operations for the three months and nine months ended September 30, 2016 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2016.

Estimation - The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Foreign Currencies - China Automotive, the parent company, and HLUSA maintain their books and records in United States Dollars, “USD,” their functional currency. The Company’s subsidiaries based in the PRC and Genesis maintain their books and records in Renminbi, “RMB,” their functional currency. The Company’s subsidiary based in Brazil maintains its books and records in Brazilian reais, “BRL,” its functional currency. In accordance with ASC Topic 830, “FASB Accounting Standards Codification”, foreign currency transactions denominated in currencies other than the functional currency are remeasured into the functional currency at the rate of exchange prevailing at the balance sheet date for monetary items. Nonmonetary items are remeasured at historical rates. Income and expenses are remeasured at the rate in effect on the transaction dates. Transaction gains and losses, if any, are included in the determination of net income for the period. 

In May 2014, the FASB and the International Accounting Standards Board (IASB) jointly issued ASU No. 2014-9, Revenue from Contracts with Customers (Topic 606), which was further updated by ASU No. 2016-08 in March 2016, ASU No.2016-10 in April 2016 and ASU No.2016-11 in May 2016. The new guidance clarifies the principles for recognizing revenue and develops a common revenue standard for GAAP and International Financial Reporting Standards (IFRS). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In July 2015, the FASB approved a deferral of the ASU effective date from annual and interim periods beginning after December 15, 2016 to annual and interim periods beginning after December 15, 2017. The Company is in the process of evaluating the impact of the ASU on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable recognition threshold for credit impairments. The new guidance broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually to include forecasted information, as well as past events and current conditions. There is no specified method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. This ASU is effective for the Company on December 15, 2019. The Company is in the process of evaluating the impact of the ASU on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting. The ASU was issued as part of the FASB Simplification Initiative and involves several aspects of accounting for share-based payment transactions, including the income tax consequences and classification on the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The Company is in the process of evaluating the impact of the ASU on its consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 refines how companies classify certain aspects of the cash flow statement in regards to debt prepayment, settlement of debt instruments, contingent consideration payments, proceeds from insurance claims and life insurance policies, distribution from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of ASU 2016-16 on its consolidated financial statements and related disclosures.

There have been no updates to the significant accounting policies set forth in the notes to the consolidated financial statements for the year ended December 31, 2015.

Pledged cash is used as guarantees for the Company’s notes payable and its use is restricted. The Company regularly pays some of its suppliers by bank notes. The Company has to make a cash deposit, generally equivalent to 40% - 100% of the face value of the relevant bank note, in order to obtain the bank note.

Short-term investments comprise of time deposits with terms of more than three months which are due within one year and wealth management financial products with maturity within one year. The carrying values of time deposits approximate fair value because of their short maturities. The interest earned is recognized in the consolidated statements of income over the contractual term of the deposits. The wealth management financial products are measured at fair value and classified as Level 2 within the fair value measurement hierarchy. The fair value was measured by using directly or indirectly observable inputs in the marketplace. Changes in the fair value are reflected in other income in the consolidated statements of operations and comprehensive income.

The Company’s short-term investments as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

As of September 30, 2016, the Company had pledged short-term investments of RMB 92.9 million, equivalent to approximately $13.9 million, to secure standby letters of credit and notes payable under China CITIC Bank, HSBC Limited, Hua Xia Bank, Shanghai Pudong Development Bank and Bank of China. The use of the pledged short-term investments is restricted.

The Company’s accounts and notes receivable as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

The Company’s inventories as of September 30, 2016 and December 31, 2015 consisted of the following (figures are in thousands of USD):

Provision for inventories amounted to $2.4 million and $1.5 million for the nine months ended September 30, 2016 and 2015, respectively.

The Company’s other receivables as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

Long-term time deposits are time deposits with maturities of longer than one year. Time deposits with original maturities of longer than one year but due within the next 12 months are included in short-term investments. As of September 30, 2016, short-term investments include $4.9 million of time deposits with original maturities of longer than one year but due within the next 12 months.

On January 24, 2010, the Company invested $3.1 million to establish a joint venture company, Beijing Henglong, with Hainachuan. The Company owns 50% of the equity in Beijing Henglong and can exercise significant influence over Beijing Henglong’s operating and financial policies. The Company accounted for Beijing Henglong’s operational results using the equity method. As of September 30, 2016 and December 31, 2015, the Company had $3.9 million and $3.8 million, respectively, of net equity in Beijing Henglong.  

On September 22, 2014, Hubei Henglong entered into an agreement with other parties to establish a venture capital fund, the “Venture Fund”, which mainly focuses on investments in emerging automobiles and parts industries. As of September 30, 2016, Hubei Henglong has completed a capital contribution of RMB 35.0 million, equivalent to approximately $5.3 million, representing 14.7% of the Venture Fund’s shares. As a limited partner, Hubei Henglong has more than virtually no influence over the Venture Fund’s operating and financial policies. The investment is accounted for using the equity method. As of September 30, 2016 and December 31, 2015, the Company had $5.5 million and $2.4 million, respectively, of net equity in the Venture Fund.  

In May 2016, Hubei Henglong entered into an agreement with other parties to establish a venture capital fund, the “Chongqing Venture Fund”. Hubei Henglong has committed to make investments of RMB 120.0 million, equivalent to approximately $18.0 million, representing 17.1% of Chongqing Venture Fund’s shares. As a limited partner, Hubei Henglong has more than virtually no influence over Chongqing Venture Fund’s operating and financial policies. The investment is accounted for using the equity method. As of September 30, 2016 and December 31, 2015, the Company had $5.7 million and nil, respectively, of net equity in Chongqing Venture Fund.

The Company’s consolidated financial statements reflect the net income of non-consolidated affiliates of $0.6 million and $0.3 million for the nine months ended September 30, 2016 and 2015, respectively.

The Company’s property, plant and equipment as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

The Company’s intangible assets as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

In accordance with the provisions of ASC Topic 740, “Income Taxes”, the Company assesses, on a quarterly basis, its ability to realize its deferred tax assets. Based on the more likely than not standard in the guidance and the weight of available evidence, the Company believes a valuation allowance against its deferred tax assets is necessary. In determining the need for a valuation allowance, the Company considered the following significant factors: an assessment of recent years’ profitability and losses by tax authorities; the Company’s expectation of profits based on margins and volumes expected to be realized, which are based on current pricing and volume trends; the long period in all significant operating jurisdictions before the expiry of net operating losses, noting further that a portion of the deferred tax asset is composed of deductible temporary differences that are subject to an expiry period until realized under tax law. The Company will continue to evaluate the provision of valuation allowance in future periods.

The components of estimated deferred income tax assets as of September 30, 2016 and December 31, 2015 are as follows (figures are in thousands of USD):

Loans consist of the following as of September 30, 2016 and December 31, 2015 (figures are in thousands of USD):

The Company’s accounts and notes payable as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

The Company’s accrued expenses and other payables as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

For the three months ended September 30, 2016 and 2015, the warranties activities were as follows (figures are in thousands of USD): 

For the nine months ended September 30, 2016 and 2015, and for the year ended December 31, 2015, the warranties activities were as follows (figures are in thousands of USD): 

The Company’s taxes payable as of September 30, 2016 and December 31, 2015 are summarized as follows (figures are in thousands of USD):

As of September 30, 2016 and December 31, 2015, advances payable by the Company were $0.9 million and $1.9 million, respectively.

The amounts are special subsidies made by the Chinese government to the Company to offset the costs and charges related to the improvement of production capacities and improvement of the quality of products. For the government subsidies with no further conditions to be met, the amounts are recorded as other income when received; for the amounts with certain operating conditions, the government subsidies are recorded as advances payable when received and will be recorded as a deduction of related expenses and cost of acquired assets when the conditions are met.

The balances are unsecured, interest-free and will be repayable to the Chinese government if the usage of such advance does not continue to qualify for the subsidy.

The Company’s positions in respect of the amounts of additional paid-in capital for the nine months ended September 30, 2016 and 2015, and the year ended December 31, 2015 are summarized as follows (figures are in thousands of USD):

Assumptions used to estimate the fair value of the stock options on the grant dates are as follows:

The above stock options were vested and exercisable immediately. Their fair value on the grant date of December 11, 2015 using the Black-Scholes option pricing model was $0.1 million. For the year ended December 31, 2015, the Company recognized stock-based compensation expenses of $0.1 million. 

Appropriated

Pursuant to the relevant PRC laws and regulations, the profits distribution of the Company’s PRC subsidiaries, which are based on their PRC statutory financial statements, rather than the financial statement that was prepared in accordance with U.S. GAAP, are available for distribution in the form of cash dividends after these subsidiaries have paid all relevant PRC tax liabilities, provided for losses in previous years, and made appropriations to statutory surplus at 10%.

When the statutory surplus reserve reaches 50% of the registered capital of a company, additional reserve is no longer required. However, the reserve cannot be distributed to venture partners. Based on the business licenses of the PRC subsidiaries, the registered capital of Henglong, Jiulong, Shenyang, USAI, Jielong, Wuhu, Hubei Henglong and Chongqing are $10.0 million, $4.2 million (equivalent to RMB 35.0 million), $8.1 million (equivalent to RMB 67.5 million), $2.6 million, $6.0 million, $3.8 million (equivalent to RMB 30.0 million), $39.0 million and $9.5 million (equivalent to RMB 60.0 million), respectively.

The Company’s activities in respect of the amounts of appropriated retained earnings for the nine months ended September 30, 2016 and 2015, and the year ended December 31, 2015 are summarized as follows (figures are in thousands of USD):

Unappropriated

The Company’s activities in respect of the amounts of the unappropriated retained earnings for the nine months ended September 30, 2016 and 2015, and the year ended December 31, 2015 are summarized as follows (figures are in thousands of USD):

The Company’s activities in respect of the amounts of the accumulated other comprehensive income for the nine months ended September 30, 2016 and 2015, and the year ended December 31, 2015 are summarized as follows (figures are in thousands of USD): 

Treasury stock represents shares repurchased by the Company that are no longer outstanding and are held by the Company. Treasury stock is accounted for under the cost method. On December 18, 2015, the Board of Directors of the Company approved a share repurchase program under which the Company may repurchase up to $5.0 million of its common stock from time to time in the open market at prevailing market prices or in privately negotiated transactions through December 17, 2016. The repurchase program shall continue unless and until (a) revoked by the Board, (b) any further repurchases at available prices would cause the Company to be unable to pay its debts as they become due in the ordinary course of its business, or (c) December 17, 2016, whichever is the earliest. During the three and nine months ended September 30, 2016, under the repurchase program, the Company had repurchased 144,554 and 259,263 shares of the Company’s common stock for cash consideration of $0.5 million and $1.0 million, respectively, on the open market. The repurchased shares are presented as “treasury stock” on the balance sheet.

The Company’s activities in respect of the amounts of the non-controlling interests’ equity for the nine months ended September 30, 2016 and 2015, and the year ended December 31, 2015 are summarized as follows (figures are in thousands of USD):  

Gain on other sales mainly consisted of net amount retained from sales of materials, property, plant and equipment, and scraps. For the nine months ended September 30, 2016, gain on other sales amounted to $2.0 million as compared to $3.2 million for the nine months ended September 30, 2015, representing a decrease of $1.2 million.  

During the nine months ended September 30, 2016 and 2015, the Company recorded financial income, net which is summarized as follows (figures are in thousands of USD):

The Company’s subsidiaries registered in the PRC are subject to national and local income taxes within the PRC at the applicable tax rate of 25% on the taxable income as reported in their PRC statutory financial statements in accordance with the relevant income tax laws applicable to foreign invested enterprise, unless preferential tax treatment is granted by local tax authorities. If the enterprise meets certain preferential terms according to the China income tax law, such as assessment as a “High & New Technology Enterprise” by the government, the enterprise will be subject to enterprise income tax at a rate of 15%.

Pursuant to the New China Income Tax Law and the Implementing Rules, “New CIT”, which became effective as of January 1, 2008, dividends generated after January 1, 2008 and payable by a foreign-invested enterprise to its foreign investors will be subject to a 10% withholding tax if the foreign investors are considered non-resident enterprises without any establishment or place within China or if the dividends payable have no connection with the establishment or place of the foreign investors within China, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement.

Genesis, the Company’s wholly-owned subsidiary and the direct holder of the equity interests in the Company’s subsidiaries in China, is incorporated in Hong Kong. According to the Mainland China and Hong Kong Taxation Arrangement, dividends paid by a foreign-invested enterprise in China to its direct holding company in Hong Kong will be subject to withholding tax at a rate of no more than 5%, if the foreign investor directly owns at least 25% of the shares of the foreign-invested enterprise. Under the New CIT, if Genesis is regarded as a non-resident enterprise, it is required to pay an additional 5% withholding tax for any dividends payable to it from the PRC subsidiaries.

According to PRC tax regulation, the Company should withhold income taxes for the profits distributed from the PRC subsidiaries to Genesis, the subsidiaries’ holding company incorporated in Hong Kong. For the profits that the PRC subsidiaries intended to distribute to Genesis, the Company accrues the withholding income tax as deferred tax liabilities. As of September 30, 2016, the Company has recognized deferred tax liabilities of $0.2 million for the remaining undistributed profits to Genesis of $4.2 million. The Company intended to re-invest the remaining undistributed profits generated from the PRC subsidiaries in those subsidiaries permanently. As of September 30, 2016 and December 31, 2015, the Company still has undistributed earnings of approximately $240.6 million and $228.7 million, respectively, from investment in the PRC subsidiaries that are considered permanently reinvested. Had the undistributed earnings been distributed to Genesis and not permanently reinvested, the tax provision as of September 30, 2016 and December 31, 2015 of approximately $12.0 million and $11.4 million, respectively, would have been recorded. Such undistributed profits will be reinvested in Genesis and not further distributed to the parent company incorporated in the United States going forward.

In 2014, Jiulong was awarded the title of “High & New Technology Enterprise” and, based on the PRC income tax law, it is subject to enterprise income tax at a rate of 15% from 2014 to 2016.

In 2014, Henglong was awarded the title of “High & New Technology Enterprise” and, based on the PRC income tax law, it is subject to enterprise income tax at a rate of 15% from 2014 to 2016.

In 2009, Shenyang was awarded the title of “High & New Technology Enterprise” and, based on the PRC income tax law, it was subject to enterprise income tax at a rate of 15% for 2009, 2010 and 2011. In 2012, the Company passed the re-assessment of the government based on PRC income tax laws. Accordingly, it continued to be taxed at the 15% tax rate in 2012, 2013 and 2014. In 2015, the Company passed the re-assessment of the government based on PRC income tax laws. Accordingly, it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017.

In 2012, Wuhu was awarded the title of “High & New Technology Enterprise” and, based on the PRC income tax law, it was subject to enterprise income tax at a rate of 15% for 2013 and 2014. In 2015, the Company passed the re-assessment of the government based on PRC income tax laws. Accordingly, it continues to be taxed at the 15% tax rate in 2015 and 2016.

In 2013, Jielong was awarded the title of “High & New Technology Enterprise” and, based on the PRC income tax law, it was subject to enterprise income tax at a rate of 15% for 2013, 2014 and 2015. The Company estimated the applied tax rate in 2016 to be 15% as it is likely to pass the re-assessment in 2016 and continue to qualify as “High & New Technology Enterprise”. 

In 2011, Hubei Henglong was awarded the title of “High & New Technology Enterprise”. Based on the PRC income tax law, it was subject to enterprise income tax at a rate of 15% for 2013. The Company has passed the re-assessment in 2014 and continues to qualify as a “High & New Technology Enterprise”. Accordingly, it continues to be taxed at the 15% tax rate in 2014, 2015 and 2016.

According to the New CIT, USAI and Testing Center are subject to income tax at a rate of 25% in 2015 and 2016.

Chongqing Henglong was established in 2012. According to the New CIT, Chongqing Henglong is subject to income tax at a uniform rate of 25%. No provision for Chongqing Henglong is made as it had no assessable income for the nine months ended September 30, 2016 and 2015.

Based on Brazilian income tax laws, Brazil Henglong is subject to income tax at a uniform rate of 15%, and a resident legal person is subject to additional tax at a rate of 10% for the part of taxable income over $0.12 million, equivalent to approximately BRL 0.24 million. The Company had no assessable income in Brazil for the nine months ended September 30, 2016 and 2015.

The profits tax rate of Hong Kong is 16.5%. No provision for Hong Kong tax is made as Genesis is an investment holding company, and had no assessable income in Hong Kong for the nine months ended September 30, 2016 and 2015.

The enterprise income tax rate of the United States is 35%. No provision for U.S. tax is made for CAAS and HLUSA as a whole, as the Company had no assessable income in the United States for the nine months ended September 30, 2016 and 2015.

The Company’s effective tax rate was 17.4% and 17.3% for the three months and nine months ended September 30, 2016, respectively, compared with 18.1% and 16.6% for the three months and nine months ended September 30, 2015, respectively.

Basic income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per share is calculated using the weighted average number of ordinary shares and dilutive ordinary share equivalents outstanding during the period. The dilutive effect of outstanding stock options is determined based on the treasury stock method.

The calculation of basic and diluted income per share attributable to the parent company for the three months ended September 30, 2016 and 2015, was (figures are in thousands of USD, except share and per share amounts):

The calculation of basic and diluted income per share attributable to the parent company for the nine months ended September 30, 2016 and 2015, was (figures are in thousands of USD, except share and per share amounts):

As of September 30, 2016 and 2015, the exercise prices for 82,500 shares and 60,000 shares, respectively, of outstanding stock options were above the weighted average market price of the Company’s common stock during the nine months ended September 30, 2016 and 2015, respectively, and these stock options were excluded from the calculation of the diluted income per share for the corresponding periods presented.

A significant portion of the Company’s business is conducted in China where the currency is the RMB. Regulations in China permit foreign owned entities to freely convert the RMB into foreign currency for transactions that fall under the "current account," which includes trade related receipts and payments, interest and dividends. Accordingly, the Company’s Chinese subsidiaries may use RMB to purchase foreign exchange for settlement of such "current account" transactions without pre-approval. However, pursuant to applicable regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with the PRC law. In calculating accumulated profits, foreign investment enterprises in China are required to allocate at least 10% of their annual net income each year, if any, to fund certain reserve funds, including mandated employee benefits funds, unless these reserves have reached 50% of the registered capital of the enterprises.

Transactions other than those that fall under the "current account" and that involve conversion of RMB into foreign currency are classified as "capital account" transactions; examples of "capital account" transactions include repatriations of investment by or loans to foreign owners, or direct equity investments in a foreign entity by a China domiciled entity. "Capital account" transactions require prior approval from China's State Administration of Foreign Exchange, or SAFE, or its provincial branch to convert a remittance into a foreign currency, such as USD, and transmit the foreign currency outside of China.

This system could be changed at any time and any such change may affect the ability of the Company or its subsidiaries in China to repatriate capital or profits, if any, outside China. Furthermore, SAFE has a significant degree of administrative discretion in implementing the laws and has used this discretion to limit convertibility of current account payments out of China. Whether as a result of a deterioration in the Chinese balance of payments, a shift in the Chinese macroeconomic prospects or any number of other reasons, China could impose additional restrictions on capital remittances abroad. As a result of these and other restrictions under the laws and regulations of the PRC, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion of their net assets to the parent. The Company has no assurance that the relevant Chinese governmental authorities in the future will not limit further or eliminate the ability of the Company’s PRC subsidiaries to purchase foreign currencies and transfer such funds to the Company to meet its liquidity or other business needs. Any inability to access funds in China, if and when needed for use by the Company outside of China, could have a material and adverse effect on the Company’s liquidity and its business.

The Company grants credit to its customers including Xiamen Joylon, Xiamen Automotive Parts, Shanghai Fenglong and Jingzhou Yude, which are related parties of the Company. The Company’s customers are mostly located in the PRC.

During the nine months ended September 30, 2016, the Company’s ten largest customers accounted for 62.7% of its consolidated net product sales, with one customer individually accounting for more than 10% of consolidated net sales i.e., 12.9%. As of September 30, 2016, approximately 3.8% of accounts receivable were from trade transactions with the aforementioned customer.

During the nine months ended September 30, 2015, the Company’s ten largest customers accounted for 69.6% of its consolidated net product sales, with one customer individually accounting for more than 10% of consolidated net sales, i.e., 13.4%. As of September 30, 2015, approximately 6.9% of accounts receivable were from trade transactions with the aforementioned customer, and there was no individual customer with a receivables balance of more than 10% of total accounts receivable.

Related party transactions are as follows (figures are in thousands of USD):

Related sales

Related purchases

Related receivables

Related advances

Related payables

These transactions were consummated under similar terms as those with the Company's third party customers and suppliers.

Hubei Wiselink pledged its land use rights and buildings with an assessed value of approximately $5.1 million as security for the Company’s entrusted government loan (See Note 13). 

As of November 10, 2016, Hanlin Chen, the Company’s Chairman, owns 56.0% of the common stock of the Company and has the effective power to control the vote on substantially all significant matters without the approval of other stockholders.

Legal proceedings

The Company is not a party to any pending or, to the best of the Company’s knowledge, any threatened legal proceedings. In addition, no director, officer or affiliate of the Company, or owner of record of more than five percent of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation.

Other commitments and contingencies

In addition to the bank loans, notes payables and the related interest, the following table summarizes the Company’s major commitments and contingencies as of September 30, 2016 (figures are in thousands of USD):

As of September 30, 2016 and December 31, 2015, the Company did not have any significant transactions, obligations or relationships that could be considered off-balance sheet arrangements.

The accounting policies of the product sectors are the same as those described in the summary of significant accounting policies except that the disaggregated financial results for the product sectors have been prepared using a management approach, which is consistent with the basis and manner in which management internally disaggregates financial information for the purposes of assisting them in making internal operating decisions. Generally, the Company evaluates performance based on stand-alone product sector operating income and accounts for inter segment sales and transfers as if the sales or transfers were to third parties, at current market prices.

As of September 30, 2016, the Company had 11 product sectors, five of which were principal profit makers and were reported as separate sectors and engaged in the production and sales of power steering (Henglong, Jiulong, Shenyang, Wuhu and Hubei Henglong), and one holding company (Genesis). The other six sectors were engaged in the production and sale of sensor modular (USAI), automobile steering columns (Jielong), provision of after sales and R&D services (HLUSA), production and sale of power steering (Chongqing Henglong), trade (Brazil Henglong), and manufacture and sales of automobile electronic systems and parts (Wuhan Chuguanjie). Since the revenues, net income and net assets of these six sectors collectively are less than 10% of consolidated revenues, net income and net assets, respectively, in the condensed unaudited consolidated financial statements, the Company incorporated these six sectors into “Other Sectors.”

As of September 30, 2015, the Company had 12 product sectors, five of which were principal profit makers and were reported as separate sectors and engaged in the production and sales of power steering (Henglong, Jiulong, Shenyang, Wuhu and Hubei Henglong), and one holding company (Genesis). The other seven sectors were engaged in the production and sale of sensor modular (USAI), automobile steering columns (Jielong), provision of after sales and R&D services (HLUSA), production and sale of power steering (Chongqing Henglong), trade (Brazil Henglong), commercial vehicle repacking and sales (Fujian Qiaolong), and manufacture and sales of automobile electronic systems and parts (Wuhan Chuguanjie). Since the revenues, net income and net assets of these seven sectors collectively are less than 10% of consolidated revenues, net income and net assets, respectively, in the condensed unaudited consolidated financial statements, the Company incorporated these seven sectors into “Other Sectors.” 

The Company’s product sector information for the three months and nine months ended September 30, 2016 and 2015, is as follows (figures are in thousands of USD):

In addition, there are other items within the Company’s financial statements that require estimation, but are not as critical as those discussed above, including provision of accounts and notes receivable. Although not significant in recent years, changes in estimates used in these and other items could have a significant effect on the Company’s consolidated financial statements.

Recent Accounting Pronouncements

Please see Note 2 to the consolidated financial statements under Item 1 of Part I of this Report.

Net Product Sales

Net product sales were $94.6 million for the three months ended September 30, 2016, compared to $90.8 million for the same period in 2015, representing an increase of $3.8 million, or 4.2%.

The Company’s net product sales were affected by the change in the product mix. With more passenger vehicles assembling electric power steering systems (EPS), the share of hydraulic power steering gears (HPS), the Company’s traditional products, is shrinking. Net sales of traditional steering products were $45.3 million for the three months ended September 30, 2016, compared to $44.7 million for the same period in 2015, representing an increase of $0.6 million, or 1.3%. Net sales of EPS were $25.6 million for the three months ended September 30, 2016, compared to $20.3 million for the same period in 2015, representing an increase of $5.3 million, or 26.1%. As a percentage of net sales, sales of EPS were 27.0% for the three months ended September 30, 2016, compared to 22.4% for the same period in 2015.

The depreciation of China’s currency, the RMB, against the U.S. dollar in the third quarter of 2016 as compared to the third quarter of 2015 had a negative impact on net sales as more than 80% of the Company’s business is conducted in China.

In summary, the Company had an increase in sales volume leading to a sales increase of $8.1 million, an increase in average selling price of steering gears leading to a sales increase of 1.8 million, and the effect of foreign currency translation of the RMB against the U.S. dollar, which led to a sales decrease of $6.1 million.

Further analysis by segment (before elimination) is as follows:

Cost of Products Sold

For the three months ended September 30, 2016, the cost of products sold was $74.6 million, compared to $74.9 million for the same period of 2015, representing a decrease of $0.3 million, or 0.4%. The decrease in the cost of products sold was mainly due to the net effect of a net increase in sales volumes which led to a cost of products sold increase of $6.9 million, a decrease in unit cost which led to a cost of products sold decrease of $2.4 million, and the effect of foreign currency translation of the RMB against the U.S. dollar which led to a cost of products sold decrease of $4.8 million. Further analysis is as follows:

Gross margin was 21.1% for the three months ended September 30, 2016, compared to 17.5% for the same period of 2015, representing an increase of 3.6%, mainly due to increased sales and the changes in the product mix in 2016.

Gain/(Loss) on Other Sales

Gain on other sales mainly consisted of net amount retained from sales of materials, property, plant and equipment, land use rights, and scraps. For the three months ended September 30, 2016, gain on other sales amounted to nil as compared to gain on other sales of $0.9 million for the three months ended September 30, 2015, representing a decrease of $0.9 million, mainly due to a decrease in gain on sales of materials.

Selling Expenses

Selling expenses were $3.8 million for the three months ended September 30, 2016, as compared to $3.3 million for the same period of 2015, representing an increase of $0.5 million, or 13.2%. The increase was mainly due to the increase in transportation expenses during that quarter since larger volumes of products were shipped to customers.

General and Administrative Expenses

General and administrative expenses were $3.7 million for the three months ended September 30, 2016, as compared to $3.1 million for the same period of 2015, representing an increase of $0.6 million, as a result of performance bonuses and increases in overall salary levels.

Research and Development Expenses

Research and development expenses were $6.7 million for the three months ended September 30, 2016, as compared to $5.4 million for the three months ended September 30, 2015. The Company’s research and development expenses were mainly used for the development and trial production of EPS and other new products. The Company’s research and development expenditures have continued to be significant in the past several years.

The global automotive parts industry is highly competitive; winning and maintaining new business requires suppliers to rapidly produce innovative products on a cost-competitive basis. In the past several years, the Company has continued to purchase advanced manufacturing equipment for newly developed products, hiring senior technicians and actively seeking external technical support.

Income from Operations

Income from operations was $5.7 million for the three months ended September 30, 2016, compared to $5.0 million for the three months ended September 30, 2015, representing an increase of $0.7 million, or 14.0%, including an increase of $4.1 million in gross profit, a decrease of $0.9 million in gain on other sales and an increase of $2.5 million in operating expenses.

Other Income, Net

Other income, net was $0.4 million for the three months ended September 30, 2016, compared to other income, net of $0.2 million for the three months ended September 30, 2015, representing an increase of $0.2 million, or 100.0%, mainly due to the subsidy from the Chinese government of $0.4 million.

Interest Expense

Interest expense was $0.2 million for the three months ended September 30, 2016, compared to $0.5 million for the three months ended September 30, 2015, representing a decrease of $0.3 million, or 60.0%, primarily due to lower interest rates compared to the same period last year.

Financial Income, Net

Financial income, net, was $0.8 million for the three months ended September 30, 2016, compared to $0.6 million for the three months ended September 30, 2015, representing an increase of $0.2 million, or 33.3%, which was mainly due to a decrease in interest income of $0.4 million and a decrease in foreign exchange loss of $0.6 million.

Income Before Income Tax Expenses and Equity in Earnings of Affiliated Companies

Income before income tax expenses and equity in earnings of affiliated companies was $6.7 million for the three months ended September 30, 2016, compared to $5.2 million for the three months ended September 30, 2015, representing an increase of $1.5 million, or 28.8%, which was mainly due to an increase in operating income of $0.7 million, an increase in other income of $0.2 million, a decrease in interest expense of $0.3 million and an increase in financial income of $0.2 million.

Income Taxes

Income tax expense was $1.2 million for the three months ended September 30, 2016, compared to $1.0 million of income tax expense for the three months ended September 30, 2015, representing an increase of $0.2 million, or 20.0%, which was mainly due to the increase in income before income tax. The income before income tax increased to $6.7 million for the three months ended September 30, 2016 from $5.2 million for the same period in 2015 and the effective tax rate decreased to 17.4% from 18.1%, which was mainly due to a decrease in income before tax of high effective tax rate subsidiaries and an increase in income before tax of low effective tax rate subsidiaries.

Net Income

Net income was $5.9 million for the three months ended September 30, 2016, compared to net income of $4.4 million for the three months ended September 30, 2015, representing an increase of $1.5 million, or 34.1%, which was mainly due to an increase in income before income tax expenses and equity in earnings of affiliated companies of $1.5 million and an increase in income tax expenses of $0.2 million.

Net Income Attributable to Non-controlling Interests

Net income attributable to non-controlling interests amounted to $0.2 million for the three months ended September 30, 2016, while net income attributable to non-controlling interests amounted to $0.1 million for the three months ended September 30, 2015.

The Company owns equity interests in seven non-wholly owned subsidiaries established in the PRC and Brazil, through which it conducts its operations. Except for Beijing Henglong, which is accounted for under the equity method, all the operating results of these non-wholly owned subsidiaries were consolidated in the Company’s financial statements as of September 30, 2016 and 2015.

Net Income Attributable to Parent Company’s Common Shareholders

Net income attributable to parent company’s common shareholders was $5.7 million for the three months ended September 30, 2016, compared with net income attributable to parent company’s common shareholders of $4.3 million for the three months ended September 30, 2015, representing an increase of $1.4 million, or 32.6%, which was mainly due to an increase in net income of $1.5 million.

Net Product Sales

Net product sales were $312.5 million for the nine months ended September 30, 2016, compared to $323.5 million for the same period in 2015, representing a decrease of $11.0 million, or 3.4%. As a result of economic slowdown in China, the GDP growth rate was maintained at 6.7% in the first three quarters of 2016, the lowest since 2009. As the major part of the Company’s business is conducted in China, China’s slow economy led to decreased vehicle sales which correspondingly led to decreased sales volumes of the Company as an auto parts supplier.

The change in product mix also caused a decline in the Company’s net product sales. With more passenger vehicles assembling electric power steering systems (“EPS”), the share of hydraulic power steering gears (“HPS”), the Company’s traditional products, is shrinking. Although the Company’s sales of EPS increased substantially, this increase is only partially offset by the decline in sales of HPS due to the low percentage of EPS in the product mix. Net sales of traditional steering products were $151.0 million for the nine months ended September 30, 2016, compared to $181.8 million for the same period in 2015, representing a decrease of $30.8 million, or 16.9%. Net sales of EPS were $85.7 million for the nine months ended September 30, 2016, compared to $66.8 million for the same period in 2015, representing an increase of $18.9 million, or 28.3%. As a percentage of net sales, sales of EPS were 27.4% for the nine months ended September 30, 2016, compared to 20.6% for the same period in 2015.

The depreciation of China’s currency, the RMB, against the U.S. dollar in the first nine months of 2016 as compared to the first nine months of 2015 also caused a decrease in net sales as more than 80% of the Company’s business is conducted in China.

In summary, the Company had an increase in sales volume leading to a sales increase of $2.8 million, an increase in average selling price of steering gears leading to a sales increase of $8.4 million, and the effect of foreign currency translation of the RMB against the U.S. dollar leading to a sales decrease of $22.1 million.

Further analysis by segment (before elimination) is as follows:

Cost of Products Sold

For the nine months ended September 30, 2016, the cost of products sold was $253.4 million, compared to $264.1 million for the same period of 2015, representing a decrease of $10.7 million, or 4.1%. The decrease in the cost of products sold was mainly due to the net effect of a net increase in sales volumes which led to a cost of products sold increase of $6.8 million, a decrease in unit cost which led to a cost of products sold decrease of $1.9 million, and the effect of foreign currency translation of the RMB against the U.S. dollar which led to a cost of products sold decrease of $15.6 million. Further analysis is as follows: