Quarterly Report (10-q)

Date : 08/14/2018 @ 9:37PM
Source : Edgar (US Regulatory)
Stock : SORL Auto Parts Inc (SORL)
Quote : 3.0836  -0.0064 (-0.21%) @ 3:28PM

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, 2018

 

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

 

For the transition period from _________ to _________

  

Commission file number 000-11991

  

SORL AUTO PARTS, INC.

 

(Exact name of registrant as specified in its charter)

 

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

  

No. 2666 Kaifaqu Avenue

Ruian Economic Development District

Rui’an City, Zhejiang Province

People’s Republic of China

 

(Address of principal executive offices)

 

86-577-6581-7720

 

(Registrant’s telephone number)

  

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

 

Yes  x   No  ¨

 

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

 

Yes  x   No  ¨

 

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

 

Large Accelerated Filer  ¨ Accelerated Filer  ¨ Non-Accelerated Filer  ¨ Smaller Reporting Company  x

 

Emerging Growth Company  ¨

 

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

 

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

 

Yes  ¨   No  x

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

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

 

As of August 14, 2018 there were 19,304,921   shares of Common Stock outstanding

 

 

 

     

 

 

SORL AUTO PARTS, INC.

 

FORM 10-Q

 

For the Quarter Ended June 30, 2018

 

INDEX

 

    Page
     
PART I. FINANCIAL INFORMATION (Unaudited)  
     
Item 1. Financial Statements:  
     
  Consolidated Balance Sheets as of June 30, 2018 (Unaudited) and December 31, 2017 3
     
  Consolidated Statements of Income and Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2018 and 2017 (Unaudited) 4
     
  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017 (Unaudited) 5
     
  Consolidated Statements of Changes in Equity for the Six months Ended June 30, 2018 (Unaudited) 6
     
  Notes to Consolidated Financial Statements (Unaudited) 7
     
Item 2. Management’s Discussion and Analysis or Financial Condition and Results of Operations 24
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33
     
Item 4. Controls and Procedures 33
     
PART II. OTHER INFORMATION 34
     
Item 1. Legal Proceedings. 34
     
Item 1A. Risk Factors. 34
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 34
     
Item 3. Defaults Upon Senior Securities. 34
     
Item 4. Mine Safety Disclosures. 34
     
Item 5. Other Information. 34
     
Item 6. Exhibits 35
     
SIGNATURES   36

 

  2  

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2018 and December 31, 2017

 

    June 30, 2018     December 31, 2017  
   

(Unaudited)

       
Assets                
Current Assets                
Cash and cash equivalents US$   24,525,413   US$   4,221,940  
Accounts receivable, net, including $1,503,376 and $1,297,734 from related party at June 30, 2018 and December 31, 2017, respectively     183,072,448       134,384,961  
Bank acceptance notes from customers     129,662,579       116,040,688  
Inventories     136,914,131       114,300,564  
Prepayments, current, including $3,440,141 and $999,527 to related party at June 30, 2018 and December 31, 2017, respectively     26,885,985       8,826,004  
Restricted cash     51,858,438       376,236  
Advances to related parties     31,997,128       72,318,224  
Other current assets, net     9,608,654       5,555,568  
Total Current Assets     594,524,776       456,024,185  
                 
Property, plant and equipment, net     84,281,312       79,828,006  
Land use rights, net     22,266,453       14,912,134  
Intangible assets, net     -       3,341  
Deposits on loan agreements     10,579,452       10,712,865  
Prepayments, non-current     31,050,766       16,594,987  
Deferred tax assets     3,566,820       4,240,424  
Total Non-current Assets     151,744,803       126,291,757  
Total Assets US$   746,269,579   US$   582,315,942  
                 
Liabilities and Equity                
Current Liabilities                
Accounts payable and bank acceptance notes to vendors, including $7,397,162 and $15,896,804 due to related parties at June 30, 2018 and December 31, 2017, respectively US$   222,438,493   US$   118,051,633  
Deposits received from customers     62,481,147       43,087,473  
Short term bank loans     162,173,062       125,380,899  
Current portion of long term loans     23,938,329       24,266,031  
Income tax payable     1,348,557       3,249,727  
Accrued expenses     19,007,341       25,154,658  
Due to related party     11,536,621       1,572,963  
Deferred income     755,675       1,020,273  
Other current liabilities     3,403,573       2,857,130  
Total Current Liabilities     507,082,798       344,640,787  
                 
Long term loans, less current portion and net of unamortized debt issuance costs     25,177,921       37,383,224  
Total Non-current Liabilities     25,177,921       37,383,224  
Total Liabilities     532,260,719       382,024,011  
                 
Equity                
Preferred stock - no par value; 1,000,000 authorized; none issued and outstanding as of June 30, 2018 and December 31, 2017     -       -  
Common stock - $0.002 par value; 50,000,000 authorized, 19,304,921 issued and outstanding as of June 30, 2018 and December 31, 2017     38,609       38,609  
Additional paid-in capital     (28,582,654 )     (28,582,654 )
Reserves     19,064,049       17,562,357  
Accumulated other comprehensive income     13,231,502       15,903,188  
Retained earnings     181,759,559       168,244,329  
Total SORL Auto Parts, Inc. Stockholders' Equity     185,511,065       173,165,829  
Noncontrolling Interest In Subsidiaries     28,497,795       27,126,102  
Total Equity     214,008,860       200,291,931  
Total Liabilities and Equity US$   746,269,579   US$   582,315,942  

 

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

 

  3  

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Income and Comprehensive Income (Loss)

For the Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

 

    Three Months Ended June 30,     Six Months Ended June 30,  
    2018     2017     2018     2017  
                         
Sales US$   128,504,952   US$   91,729,568   US$   236,231,634   US$   16 6,475,962  
Include: sales to related parties     5,962,527       2,702,573       13,663,581       6,322,970  
Cost of sales     94,074,682       67,056,897       171,601,878       120,757,355  
Gross profit     34,430,270       24,672,671       64,629,756       45,718,607  
                                 
Expenses:                                
Selling and distribution expenses     13,956,009       8,985,562       23,993,870       14,594,185  
General and administrative expenses     7,694,411       4,710,522       12,468,189       8,755,435  
Research and development expenses     5,331,956       2,481,563       8,922,358       4,536,659  
Total operating expenses     26,982,376       16,177,647       45,384,417       27,886,279  
                                 
Other operating income, net     2,379,227       288,472       4,576,551       578,709  
                                 
Income from operations     9,827,121       8,783,496       23,821,890       18,411,037  
                                 
Interest income     811,580       11,475       2,299,844       22,025  
Government grants     609,592       84,395       743,525       113,304  
Other income     175,627       50       202,693       714  
Interest expenses     (3,529,416 )     (542,176 )     (6,883,127 )     (1,023,336 )
Exchange differences     1,091,208       (417,118 )     489,922       (509,850 )
Other expenses     (254,271 )     (25,490 )     (1,145,085 )     (140,289 )
                                 
Income before income taxes provision     8,731,441       7,894,632       19,529,662       16,873,605  
                                 
Provision for income taxes     1,238,752       1,311,509       2,844,193       2,597,683  
                                 
Net income US$   7,492,689   US$   6,583,123   US$   16,685,469   US$   14,275,922  
                                 
Net income attributable to noncontrolling interest in subsidiaries     749,269       658,312       1,668,547       1,427,592  
                                 
Net income attributable to common stockholders US$   6,743,420   US$   5,924,811   US$   15,016,922   US$   12,848,330  
                                 
Comprehensive income:                                
                                 
Net income US$   7,492,689   US$   6,583,123   US$   16,685,469   US$   14,275,922  
Foreign currency translation adjustments     (11,013,074 )     3,223,520       (2,968,540 )     4,134,952  
Comprehensive income (loss)     (3,520,385 )     9,806,643       13,716,929       18,410,874  
Comprehensive income (loss) attributable to noncontrolling interest in subsidiaries     (352,038 )     980,664       1,371,693       1,841,087  
Comprehensive income (loss) attributable to common stockholders US$   (3,168,347 ) US$   8,825,979   US$   12,345,236   US$   16,569,787  
                                 
Weighted average common share - basic     19,304,921       19,304,921       19,304,921       19,304,921  
                                 
Weighted average common share - diluted     19,304,921       19,304,921       19,304,921       19,304,921  
                                 
EPS - basic US$   0.35   US$   0.31   US$   0.78   US$   0.67  
                                 
EPS - diluted US$   0.35   US$   0.31   US$   0.78   US$   0.67  

 

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

 

  4  

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the Six Months Ended June 30, 2018 and 2017 (Unaudited)

 

    Six Months Ended June 30,  
    2018     2017  
             
Cash Flows From Operating Activities                
Net income US$   16,685,469   US$   14,275,922  
Adjustments to reconcile net income to net cash                
provided by (used in) operating activities:                
                 
Allowance for doubtful accounts     1,445,353       381,715  
Depreciation and amortization     5,832,558       4,187,811  
Amortization of debt issuance costs     697,633       4,566  
Gain on disposal of fixed assets     (73,809 )     -  
Deferred income tax     642,345       -  
Changes in assets and liabilities:                
Account receivable     (52,930,675 )     (16,819,493 )
Bank acceptance notes from customers     36,822,604       3,181,918  
Other currents assets     (5,158,214 )     (3,197,226 )
Inventories     (24,642,342 )     (16,436,720 )
Prepayments, current     (25,749,865 )     4,815,945  
Accounts payable and bank acceptance notes to vendors     99,655,568       (395,358 )
Income tax payable     (1,918,494 )     438,458  
Deposits received from customers     20,470,159       8,402,222  
Deferred income     (259,132 )     -  
Other current liabilities and accrued expenses     (5,426,422 )     (2,087,738 )
Net Cash Flows Provided By (Used In) Operating Activities     66,092,736       (3,247,978 )
                 
Cash Flows From Investing Activities                
Acquisition of property, equipment and land use rights     (33,712,960 )     (29,561,593 )
Advances to related parties     (190,438,634 )     -  
Repayments of advances to related parties     222,337,244       -  
Net Cash Flows Used In Investing Activities     (1,814,350 )     (29,561,593 )
                 
Cash Flows From Financing Activities                
Proceeds from short term bank loans     296,959,191       41,540,998  
Repayments of short term bank loans     (256,944,835 )     (23,035,449 )
Proceeds from related parties     311,026,410       62,786,671  
Repayments to related parties     (328,443,191 )     (54,076,148 )
Repayments of long term loans     (12,800,786 )     -  
Net Cash Flows Provided By Financing Activities     9,796,789       27,216,072  
                 
Effects on changes in foreign exchange rate     (2,289,500 )     314,449  
                 
Net change in cash, cash equivalents, and restricted cash     71,785,675       (5,279,050 )
                 
Cash, cash equivalents, and restricted cash - beginning of the period     4,598,176       13,533,776  
                 
Cash, cash equivalents, and restricted cash - end of the period US$   76,383,851   US$   8,254,726  
                 
                 
Supplemental Cash Flow Disclosures:                
Interest paid US$   5,521,273   US$   785,502  
Income taxes paid US$   4,120,342   US$   2,154,659  
                 
Non-cash Investing and Financing Transactions                
Loans from related parties in the form of bank acceptance notes US$   33,721,267   US$   14,375,855  
Repayments to related party in the form of bank acceptance notes US$   5,846,083   US$   -  
Repayments from related party in the form of bank acceptance notes US$   19,612,146   US$   -  
                 
Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets                
Cash and cash equivalents US$   24,525,413   US$   7,892,336  
Restricted cash     51,858,438       362,390  
Total cash, cash equivalents, and restricted cash US$   76,383,851   US$   8,254,726  

   

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

 

  5  

 

 

SORL Auto Parts, Inc. and Subsidiaries

Consolidated Statements of Changes in Equity

For the Six Months Ended June 30, 2018 (Unaudited)

 

   

Number

of Share

    Common Stock    

Additional

Paid-in

Capital

    Reserves    

Retained

Earnings

   

Accumulated

Other

Comprehensive

Income

   

Total SORL

Auto

Parts, Inc.

Stockholders'

Equity

   

Noncontrolling

Interest

   

Total

Equity

 
Balance as of December 31, 2017     19,304,921     $ 38,609     $ (28,582,654 )   $ 17,562,357     $ 168,244,329     $ 15,903,188     $ 173,165,829     $ 27,126,102     $ 200,291,931  
                                                                         
Net income     -       -       -       -       15,016,922       -       15,016,922       1,668,547       16,685,469  
                                                                         
Foreign currency translation adjustment     -       -       -       -       -       (2,671,686 )     (2,671,686 )     (296,854 )     (2,968,540 )
                                                                         
Transfer to reserve     -       -       -       1,501,692       (1,501,692 )     -       -       -       -  
                                                                         
Balance as of June 30, 2018     19,304,921     $ 38,609     $ (28,582,654 )   $ 19,064,049     $ 181,759,559     $ 13,231,502     $ 185,511,065     $ 28,497,795     $ 214,008,860  

 

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

 

  6  

 

 

SORL Auto Parts, Inc. and Subsidiaries

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2018

 

(Unaudited)

 

NOTE A - DESCRIPTION OF BUSINESS

 

SORL Auto Parts, Inc. (together with its subsidiaries, “we,” “us,” “our” or the “Company” or “SORL”), a Delaware corporation incorporated on March 24, 1982, is principally engaged in the manufacture and distribution of vehicle brake systems and other key safety-related components, through its 90% ownership of Ruili Group Ruian Auto Parts Co., Ltd. (the “Joint Venture” or “Ruian”). The Company distributes products both in China and internationally under SORL trademarks. The Company’s product range includes 140 categories and over 2,000 different specifications.

 

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

 

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

 

  7  

 

 

NOTE B - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

(1) BASIS OF PRESENTATION

 

The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All intercompany balances and transactions have been eliminated in the consolidation. Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted as permitted by the rules and regulations of the United States Securities and Exchange Commission (“SEC”), although the Company believes that the disclosures contained in this report are adequate to make the information presented not misleading. The consolidated balance sheet information as of December 31, 2017 was derived from the consolidated audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. These consolidated financial statements should be read in conjunction with the annual consolidated audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, and other reports filed with the SEC.

 

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

 

(2) SIGNIFICANT ACCOUNTING POLICIES

 

a. ACCOUNTING METHOD

 

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

 

b. USE OF ESTIMATES

 

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

 

  8  

 

 

c. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

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

 

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

 

d. RESTRICTED CASH

 

Restricted cash consists of bank deposits used to pledge bank acceptance notes and short term bank loans, deposits for obtaining letters of credit from a local bank and bank deposits used as down payment secured on behalf of a related party for potential acquisition.

 

The Company entered into credit agreements with commercial banks in China (“endorsing banks”) which agree to provide credit within stipulated limits. Within the stipulated credit limits, the Company can issue bank acceptance notes to its suppliers as payments for the purchases. In order to issue bank acceptance notes, the Company is generally required to make initial deposits or pledge notes receivable to the endorsing banks in amounts of certain percentage of the face amount of the bank acceptance notes to be issued by the Company. The cash in such accounts is restricted for use over the terms of the bank acceptance notes, which are normally three to six months. As of June 30, 2018 and December 31, 2017, restricted cash of $36,766,952 and $0, respectively, was used to pledge the bank acceptance notes.

 

During the six months ended June 30, 2018, the Company obtained a short term bank loan in the amount of $2,824,538 from Industrial and Commercial Bank of China, which required a pledge with bank deposits of $2,872,412. As of June 30, 2018, the bank deposits remained as the pledge for the loan. Also see Note K for details.

 

The Company also obtained letters of credit from Industrial Bank Co., Ltd. and China Zheshang Bank, which agreed to provide guarantee that the Company would make timely payment to its suppliers for any purchases. Deposits of $3,899,284 and $275,474, respectively, were required for this purpose as of June 30, 2018 and December 31, 2017.

 

As of June 30, 2018, the Company had a bank deposit of $5,297,090(RMB 35,048,725), representing an advance to Ruili Group. The Company also had a bank deposit of $3,022,700 (RMB 20,000,000) as a security deposit of loans obtained by Wenzhou Lichuang Automobile Parts Co., Ltd., a related party, from China Merchant Bank. Also see Note E for details.

 

  9  

 

 

e. RELATED PARTY TRANSACTIONS

 

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

 

f. BANK ACCEPTANCE NOTES RECEIVABLE

 

Bank acceptance notes receivable, generally due within six months and with specific payment terms and definitive due dates, are comprised of the notes issued by some customers to pay certain outstanding receivable balances to the Company, and the notes issued by the customers of related parties and transferred to the Company as loans from related parties or repayments from related parties. Bank acceptance notes do not bear interest. As of June 30, 2018 and December 31, 2017, bank acceptance notes receivable in the amount of $95,528,975 and $95,914,724, respectively, were pledged to banks to issue either short term bank loans or bank acceptance notes to vendors. The banks charge discount fees if the Company chooses to discount the bank acceptance notes for cash before the maturity of the notes and such discount fees are included in interest expenses in the accompanying unaudited consolidated statements of income and comprehensive income (loss).

 

g. REVENUE RECOGNITION

 

The Company has adopted Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“ASC 606”) effective as of January 1, 2018. The Company has chosen to use the full retrospective transition method, under which it is required to revise its consolidated financial statements for the year ended December 31, 2017 as well as any applicable interim periods within the year ended December 31, 2017, as if ASC 606 had been effective for those periods. Under ASC 606, the Company recognizes revenue when a customer obtains control of promised goods, in an amount that reflects the consideration which the Company expects to receive in exchange for the goods. To determine revenue recognition for arrangements within the scope of ASC 606, the Company performs the following five steps: (1) identify the contracts with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when or as the entity satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods it transfers to the customer. See Note C for assessment on the impact of adopting ASC 606, and Note M for details on revenues from contracts with customers.

 

  10  

 

 

h . FOREIGN CURRENCY TRANSLATION

 

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

 

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

 

NOTE C – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

In May 2014, the FASB issued ASC 606. ASC 606 outlines a single set of comprehensive principles for recognizing revenue under U.S. GAAP and supersedes the revenue recognition guidance existed at the time. The main principle of ASC 606 is that revenue should be recognized 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 to in exchange for those goods or services. The Company applied the ASC and its related updates on a full retrospective basis as of January 1, 2018. The adoption of ASC 606 did not impact the previously reported financial statements in any prior period nor did it result in a cumulative effect adjustment to retained earnings. See Note M for additional information.

 

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. These amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments do not provide a definition of restricted cash or restricted cash equivalents. The Company adopted ASU 2016-18 effective January 1, 2018. As a result of the adoption, net cash used in investing activities was adjusted to exclude the change in restricted cash, resulting in an increase of $5,198,792 in net cash used in investing activities in the amount previously reported for the six months ended June 30, 2017. Restricted cash was included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the consolidated statements of cash flows.

 

In July 2018, the FASB issued ASU 2018-09, “Codification Improvements”, which affects a wide variety of Topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. These amendments represent changes to clarify, correct errors in, or make minor improvements to the Codification, eliminating inconsistencies and providing clarifications in current guidance. Some of the amendments do not require transition guidance and will be effective upon issuance. However, many of the amendments do have transition guidance with effective dates for annual periods beginning after December 15, 2018, for public business entities. The Company is currently evaluating the impact of the adoption of ASU No. 2018-09 on its consolidated financial statements.

 

In July 2018, the FASB issued ASU 2018-10, “Codification Improvements to Topic 842, Leases”. These amendments affect narrow aspects of the guidance issued in the amendments in ASU 2016-02 including those regarding residual value guarantees, rate implicit in the lease, lessee reassessment of lease classification, lessor reassessment of lease term and purchase option, variable lease payments that depend on an index or a rate, investment tax credits, lease term and purchase option, transition guidance for amounts previously recognized in business combinations, certain transition adjustments, transition guidance for leases previously classified as capital leases under Topic 840, transition guidance for modifications to leases previously classified as direct financing or sales-type leases under Topic 840, transition guidance for sale and leaseback transactions, impairment of net investment in the lease, unguaranteed residual asset, effect of initial direct costs on rate implicit in the lease, and failed sale and leaseback transactions. For entities that early adopted Topic 842, the amendments are effective upon issuance of ASU 2018-10, and the transition requirements are the same as those in Topic 842. For entities that have not adopted Topic 842, the effective date and transition requirements will be the same as the effective date and transition requirements in Topic 842. The Company is currently evaluating the impact of the adoption of ASU No. 2018-10 on its consolidated financial statements.

 

In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements”. The amendments in this ASU affect the guidance issued in ASU 2016-02, Leases (Topic 842), which is not yet effective. The amendments provide entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The amendments also provide lessors with a practical expedient to not separate non-lease components from the associated lease component and, instead, to account for those components as a single component in certain circumstances. For the entities that have not adopted Topic 842,the effective date for this ASU are the same as those for ASU 2016-02, which is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of ASU No. 2018-11 on its consolidated financial statements.

 

NOTE D – RECLASSIFICATIONS

 

Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no impact on net earnings or financial position.

 

  11  

 

 

NOTE E - RELATED PARTY TRANSACTIONS

 

Related parties with whom the Company conducted business consist of the following:

 

Name of Related Party   Nature of Relationship
Xiao Ping Zhang   Principal shareholder, Chairman of the Board and Chief Executive Officer
     
Shu Ping Chi   Shareholder, member of the Board, wife of Xiao Ping Zhang
     
Xiao Feng Zhang   Shareholder, member of the Board, brother of Xiao Ping Zhang
     
Ruili Group Co., Ltd. ("Ruili Group")   10% shareholder of Joint Venture and is collectively controlled by Xiao Ping Zhang, Shu Ping Chi, and Xiao Feng Zhang
     
Guangzhou Ruili Kormee Automotive Electronic Co., Ltd. ("Guangzhou Kormee")   Controlled by Ruili Group
     
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd. (“Ruian Kormee” and formerly known as “Ruian Kormee Automobile Braking Co., Ltd.”)   Wholly controlled by Guangzhou Kormee
     
Shanghai Dachao Electric Technology Co., Ltd. ("Shanghai Dachao")   Ruili Group holds 66% of the equity interests in Shanghai Dachao
     
Ruili MeiLian Air Management System (LangFang) Co., Ltd. ("Ruili Meilian")   Controlled by Ruili Group
     
Wenzhou Lichuang Automobile Parts Co., Ltd. ("Wenzhou Lichuang")   Controlled by Ruili Group
     
Ningbo Ruili Equipment Co., Ltd. ("Ningbo Ruili")   Controlled by Ruili Group
     
Shanghai Ruili Real Estate Development Co., Ltd. ("Shanghai Ruili")   Wholly owned by Ruili Group
     
Kunshan Yuetu Real Estate Development Co., Ltd. ("Kunshan Yuetu")   Collectively owned by Ruili Group and Shu Ping Chi
     
Shanghai Tabouk Auto Components Co., Ltd. ("Shanghai Tabouk")   Collectively owned by Xiao Feng Zhang and Xiao Ping Zhang
     
Hangzhou Ruili Property Development Co., Ltd.   Collectively owned by Ruili Group and Xiao Ping Zhang

 

The Company continues to purchase primarily packaging materials from Ruili Group. In addition, the Company purchases automotive components from other related parties, including Guangzhou Kormee, Ruian Kormee, Ruili Meilian, Shanghai Dachao, Wenzhou Lichuang and Ningbo Ruili. As of June 30, 2018, the Company did not receive any materials from Ningbo Ruili purchased during the three and six months then ended. The unreceived purchases from the relate party are recorded as prepayments, current on the accompanying consolidated balance sheets.

 

The Company sells certain automotive products to the Ruili Group. The Company also sells parts to Guangzhou Kormee, Shanghai Tabouk, Ruian Kormee and Ruili Meilian. 

 

  12  

 

 

The following related party transactions occurred for the three and six months ended June 30, 2018 and 2017:

 

    Three Months Ended June 30,     Six Months Ended June 30,  
    2018     2017     2018     2017  
PURCHASES FROM:                                
Guangzhou Ruili Kormee Automotive Electronic Co., Ltd.   $ 1,744,095     $ 989,679     $ 1,744,095     $ 1,325,606  
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd.     1,057,603       401,132       1,413,096       756,803  
Shanghai Dachao Electric Technology Co., Ltd.     231,069             376,687       55,230  
Ruili MeiLian Air Management System (LangFang) Co., Ltd.     2,503,163       1,373,241       4,974,406       2,156,311  
Ruili Group Co., Ltd.     2,249,962       1,382,956       3,966,750       2,509,674  
Wenzhou Lichuang Automobile Parts Co., Ltd.     5,763,176             7,544,892        
Total purchases   $ 13,549,068     $ 4,147,008     $ 20,019,926     $ 6,803,624  
SALES TO:                                
Guangzhou Ruili Kormee Automotive Electronic Co., Ltd.   $ 3,461,778     $ 972,084     $ 5,814,806     $ 1,749,441  
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd.     54,470       12,187       54,470       12,187  
Ruili MeiLian Air Management System (LangFang) Co., Ltd.     313,940       388,287       843,813       388,287  
Ruili Group Co., Ltd.     1,664,885       900,859       6,076,172       3,927,783  
Shanghai Tabouk Auto Components Co., Ltd.     467,454       429,156       874,320       633,559  
Total sales   $ 5,962,527     $ 2,702,573     $ 13,663,581     $ 6,711,257  

 

    As of June 30, 2018     As of December 31, 2017  
ADVANCES TO RELATED PARTIES                
Ruili Group Co., Ltd.   $ 31,194,813     $ 5,711,605  
Shanghai Ruili Real Estate Development Co., Ltd.     645,275       65,069,497  
Kunshan Yuetu Real Estate Development Co., Ltd.     157,040       1,537,122  
Total advances to related parties   $ 31,997,128     $ 72,318,224  
                 
ACCOUNTS RECEIVABLE                
Shanghai Tabouk Auto Components Co., Ltd.   $ 1,503,376     $ 1,297,734  
Total accounts receivable   $ 1,503,376     $ 1,297,734  
                 
PREPAYMENTS, CURRENT                
Ningbo Ruili Equipment Co., Ltd.   $ 3,440,141     $ 999,527  
Total prepayments, current   $ 3,440,141     $ 999,527  
                 
ACCOUNTS PAYABLE TO RELATED PARTIES                
Guangzhou Ruili Kormee Automotive Electronic Control Technology Co., Ltd.   $ 1,311,917     $ 3,414,719  
Shanghai Dachao Electric Technology Co., Ltd.     18,173       83,178  
Ruili MeiLian Air Management System (LangFang) Co., Ltd.     3,731,822       1,993,787  
Wenzhou Lichuang Automobile Parts Co., Ltd.     2,335,250       10,405,120  
Total accounts payable to related parties   $ 7,397,162     $ 15,896,804  
                 
DUE TO RELATED PARTY                
Wenzhou Ruili Kormee Automotive Electronics Co., Ltd.   $ 11,536,621     $ 1,572,963  
Total due to related party   $ 11,536,621     $ 1,572,963  

   

  13  

 

 

From time to time, the Company borrows from Ruili Group and its controlled companies for working capital purposes. In order to obtain the loans and mutually benefit both the debtor and creditor of the arrangement, the Company also advances to Ruili Group and its controlled companies in a short term. All the loans from related parties are non-interest bearing, unsecured and due on demand. The advances to Ruili Group are non-interest bearing, unsecured, and due on demand and the advances to Shanghai Ruili and Kunshan Yuetu are due on demand, unsecured, and bear an interest rate of 5.22% per annum. The advances to Shanghai Ruili and Kunshan Yuetu were fully repaid as of June 30, 2018.

 

During the six months ended June 30, 2018, the Company obtained loans of $311,026,410 in cash and $33,721,267 in the form of bank acceptance notes from related parties. Repayments in cash and bank acceptance notes to related parties totaled $328,443,191 and $5,846,083, respectively. In the same period, the Company advanced to its related parties in the total amount of $190,438,634 and received cash repayments from related parties amounted to $222,337,244. Amount due from Shanghai Ruili and Kunshan Yuetu as of June 30, 2018 represented the interest receivable from the two related parties, which was paid as of the filing date. During the six months ended June 30, 2017, the Company obtained loans of $62,786,671 in cash and $14,375,855 in the form of bank acceptance notes from related parties. Repayments in cash to related parties amounted to $54,076,148.

 

The Company entered into a lease agreement with Ruili Group. See Note O for more details.

 

During the six months ended June 30, 2018, the Company made a bank deposit of $5,297,090 (RMB 35,048,725) as down payment to secure a potential acquisition. Initially, the Company had the intention to acquire the target company and deposited $5,297,090 (RMB 35,048,725) into a trust account restricted for the use in the potential acquisition. After a few rounds of discussion, the Company gave up and Ruili Group decided to do the acquisition. As the Company and Ruili Group are under common control, the restricted deposit represented an advance to Ruili Group, non-interest bearing, due on demand and non-secured. Also see Note B.

 

During the six months ended June 30, 2018, the Company made a bank deposit of $3,022,700 (RMB 20,000,000) as security deposit for loans obtained by Wenzhou Lichuang from China Merchant Bank. Also see Note B.

 

The Company provided a guarantee for the credit line granted to Ruili Group by the China Merchants Bank in the amount of RMB 50,000,000 (approximately $7,699,889) for a period from July 29, 2015 until two years after the due date of each loan withdrawn by Ruili Group under the credit line. The credit line was replaced by the one issued by the same bank in the amount of RMB 40,000,000 (approximately $5,766,181) for a period of 12 months starting on October 24, 2016. The credit line was renewed on October 19, 2017 for 6 months. On April 23, 2018, Ruili Group and the bank reached another extension agreement and the guarantee will be provided by the Company until April 23, 2021.

 

The Company provided a guarantee for the credit line granted to Ruili Group by China Guangfa Bank in a maximum amount of RMB 69,000,000 (approximately $10,092,000) for the period from November 16, 2016 to January 16, 2018. The credit line was renewed on December 21, 2017 for a period of 12 months, and the guarantee was accordingly extended by the Company as of June 30, 2018 and will expire on December 20, 2018.

 

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

 

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

 

  14  

 

 

NOTE F - ACCOUNTS RECEIVABLE, NET

 

Accounts receivable, net consisted of the following: 

 

    June 30,     December 31,  
    2018     2017  
             
Accounts receivable   $ 197,964,158     $ 148,312,117  
Less: allowance for doubtful accounts     (14,891,710 )     (13,927,156 )
Accounts receivable, net   $ 183,072,448     $ 134,384,961  

 

No customer individually accounted for more than 10% of our revenues or accounts receivable for the six months ended June 30, 2018 and 2017. The changes in the allowance for doubtful accounts at June 30, 2018 and December 31, 2017 are summarized as follows:

 

    June 30,     December 31,  
    2018     2017  
Beginning balance   $ 13,927,156     $ 11,686,417  
Add: increase to allowance     1,445,353       1,474,872  
Less: accounts written off     -       -  
Effects on changes in foreign exchange rate     (480,799 )     765,867  
Ending balance   $ 14,891,710     $ 13,927,156  

  

NOTE G - INVENTORIES

 

At June 30, 2018 and December 31, 2017, inventories consisted of the following:

 

    June 30,     December 31,  
    2018     2017  
Raw materials   $ 32,018,882     $ 27,657,266  
Work-in-process     29,346,093       40,805,434  
Finished goods     75,549,156       45,837,864  
Less: write-down of inventories     -       -  
Total inventories   $ 136,914,131     $ 114,300,564  

 

  15  

 

 

NOTE H - PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment consisted of the following at June 30, 2018 and December 31, 2017:

 

    June 30,     December 31,  
    2018     2017  
Machinery   $ 126,872,185     $ 119,296,564  
Molds     1,322,238       1,338,912  
Office equipment     3,260,035       2,998,443  
Vehicles     4,337,091       3,681,194  
Buildings     20,199,324       20,127,148  
Leasehold improvements     480,771       486,834  
Sub-total     156,471,644       147,929,095  
                 
Less: accumulated depreciation     (72,190,332 )     (68,101,089 )
                 
Property, plant and equipment, net   $ 84,281,312     $ 79,828,006  

 

Depreciation expense charged to operations was $5,531,002 and $4,041,628 for the six months ended June 30, 2018 and 2017, respectively.

 

NOTE I – LAND USE RIGHTS, NET

 

The balances for land use rights, net, as of June 30, 2018 and December 31, 2017 are as the following:

 

    June 30, 2018     December 31, 2017  
Cost   $ 23,114,290     $ 15,477,081  
Less: accumulated amortization     (847,837 )     (564,947 )
Land use rights, net   $ 22,266,453     $ 14,912,134  

 

In September 2017, the Company entered into an agreement with the Ministry of Land and Resources, Ruian, to purchase the land use rights for the land located at the intersection of Xianghe Road and North Wansong Road, Binhai New District, Ruian City, Zhejiang Province, China (the “Wansong Land”). Full payment of RMB 51.81 million (approximately $7.93 million) was made as of December 31, 2017. The Company obtained the title to the land use rights in April 2018. The Wansong Land has a total area of 17,029 square meters.

 

In December 2017, the Company entered into an agreement with the Ministry of Land and Resources, Ruian, to purchase the land use rights for the land located at the intersection of Fengjin Road and Wenhua Road, Binhai New District, Ruian City, Zhejiang Province, China. Prepayment of RMB 14.40 million (approximately $2.14 million) was made as down payment in 2017. During the six months ended June 30, 2018, the Company paid additional amount of RMB 57.62 million (approximately $8.99 million). As of June 30, 2018, the purchase price of RMB 72.02 (approximately $11.13 million) was fully paid. As of the filing date, the title to the land use rights has not been transferred. The payments were included in prepayment, non-current as of June 30, 2018 on the accompanying consolidated balance sheets.

 

In April 2018, the Company entered into an agreement with the Ministry of Land and Resources, Ruian, to purchase the land use rights for the land located at the intersection of Tengda Road and Wanghai Road, Economic Development District, Ruian City, Zhejiang Province, China. Prepayment of RMB 42.54 million (approximately $6.43 million) was made during the six months ended June 30, 2018. As of the filing date, the title to the land use rights has not been transferred. The payments were included in prepayment, non-current as of June 30, 2018 on the accompanying consolidated balance sheets.

 

Amortization expenses were $301,556 and $141,816 for the six months ended June 30, 2018 and 2017, respectively.

 

NOTE J - DEFERRED TAX ASSETS

 

Deferred tax assets consisted of the following as of June 30, 2018 and December 31, 2017:

 

    June 30,     December 31,  
    2018     2017  
Deferred tax assets – non-current                
Allowance for doubtful accounts   $ 2,322,376     $ 2,137,837  
Revenue (net of cost)     100,389       160,766  
Unpaid accrued expenses     21,558       955,287  
Warranty     1,122,497       986,534  
Deferred tax assets     3,566,820       4,240,424  
Valuation allowance     -       -  
Net deferred tax assets – non-current   $ 3,566,820     $ 4,240,424  

 

  16  

 

 

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’s subsidiary registered in the PRC is subject to income taxes within the PRC at the applicable tax rate.

 

NOTE K – SHORT TERM BANK LOANS

 

Bank loans represented the following as of June 30, 2018 and December 31, 2017:

 

   

June 30,

2018

   

December 31,

2017

 
             
Secured   $ 159,452,631     $ 125,380,899  
Unsecured     2,720,431       -  
Total short term bank loans   $ 162,173,062     $ 125,380,899  

  

The Company obtained those short term loans from Bank of China, Bank of Ningbo, Agricultural Bank of China, China Zheshang Bank, China CITIC Bank, China Minsheng Bank, Industrial Bank Co., Ltd., Oversea-Chinese Banking Corporation Limited, Industrial and Commercial Bank of China, Huaxia Bank and China Construction Bank, respectively, to finance general working capital and acquire long-lived assets. Interest rate for the loans outstanding during the six months ended June 30, 2018 ranged from 0.90% to 5.72% per annum. The maturity dates of the loans existing as of June 30, 2018 ranged from July 16, 2018 to June 12, 2019. As of June 30, 2018 and December 31, 2017, the Company’s accounts receivable of $659,619 and $5,472,169, respectively, were pledged as collateral under loan arrangements. The interest expenses for short term bank loans, including discount fees, were $2,590,729 and $542,176 for the three months ended June 30, 2018 and 2017, respectively. The interest expenses for short term bank loans, including discount fees, were $4,885,057 and $1,003,088 for the six months ended June 30, 2018 and 2017, respectively. 

 

  17  

 

 

As of June 30, 2018, corporate or personal guarantees provided for those bank loans were as follows: 

 

$ 5,778,084     Guaranteed by Ruili Group, a related party
$ 12,589,079     Guaranteed by Ruili Group, a related party; Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders
$ 27,204,304     Pledged by Hangzhou Ruili Property Development Ltd., a related party under common control, with its properties; Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders
$ 19,015,396     Pledged by Ruili Group, a related party, with its land use rights and properties
$ 2,824,538     Pledged by the Company with a bank deposit of $2,872,412, which was included in restricted cash on the accompanying unaudited consolidated balance sheets. Also see Note B “RESTRICTED CASH” section
$ 26,297,494     Pledged by the Company with its bank acceptance notes
$ 5,289,726     Pledged by Shanghai Ruili, a related party, with its properties; Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders; Guaranteed by Ruili Group, a related party
$ 60,454,010     Pledged by Shanghai Ruili, a related party, with its properties. Guaranteed by Mr. Xiao Ping Zhang and Ms. Shu Ping Chi, both the Company’s principal stockholders

 

NOTE L - LONG TERM LOANS

 

    March 31, 2018     December 31, 2017  
Aggregate outstanding principal balance   $ 50,237,609     $ 63,471,308  
Less: unamortized debt issuance costs     (1,121,359 )     (1,822,053 )
Less: current portion     (23,938,329 )     (24,266,031 )
Non-current portion   $ 25,177,921     $ 37,383,224  

 

In November 2017, the Company entered into two identical but independent loan agreements with Far Eastern Horizon Co., Ltd. (“Far Eastern”), each for a term of 36 months and with an effective interest rate of 8.38% per annum, payable monthly in arrears. The total long term obligations under the two agreements amounted to RMB 200,000,000 (approximately $30,608,185), pledged by the Company’s equipment in the original cost of RMB 205,690,574 (approximately $31,479,075). The Company paid debt issuance costs in cash of $742,324. For the six months ended June 30, 2018, the repayments of principal totaled $5,083,153.

 

  18  

 

 

In November 2017, the Company entered into four independent loan agreements with COSCO Shipping Leasing Co., Ltd. (“COSCO”) for a term of 36 months each. Two of the agreements were signed on November 30, 2017 with an effective interest rate of 8.50% per annum, payable monthly in arrears. The other two agreements were entered into on November 15, 2017, with an effective interest rate of 4.31% per annum, payable monthly in arrears. The total long term obligations under the four agreements amounted to RMB 235,000,000 (approximately $35,964,617), pledged by the Company’s equipment in the original cost of RMB 238,333,639 (approximately $36,474,800). The Company paid debt issuance costs in cash in the amount of $1,025,248. For the six months ended June 30, 2018, the repayments of principal totaled $7,717,633.

 

The interest expenses for long term loans, including the amortization of debt issuance costs, were $938,687 for the three months ended June 30, 2018. The interest expenses for long term loans, including the amortization of debt issuance costs, were $1,998,070 for the six months ended June 30, 2018.

 

NOTE M – REVENUES FROM CONTRACTS WITH CUSTOMERS

 

The Company accounted for revenue in accordance with ASC 606, which was adopted on January 1, 2018, using full retrospective method. The adoption of the standard did not impact the Company’s revenue recognition.

 

The Company provides a variety of standard products to its customers. The Company’s contracts with its customers consist of a single, distinct performance obligation or promise to transfer auto parts to the customers. Generally, the Company’s performance obligations are satisfied when the customers take possession of the products, which normally occurs at the shipping point or destination depending on the terms of the contracts. All sales are recorded net of value-added taxes. The Company does not recognize revenue related to product warranties. See Note P for details concerning the expected costs associated with the Company’s assurance warranty obligations.

 

In accordance with ASC 606, the Company disaggregates revenue from contracts with customers by product type. See Note Q for information regarding revenue disaggregation by product type.

 

Revenues from contracts with customers are recognized at a point in time when the merchandises are delivered to the customer in accordance with the shipping terms stated in the contracts, which is the point when the legal title, physical possession and the risks and rewards of ownership are transferred to the customers.

 

Deferred revenue is recorded when consideration is received from a customer prior to transferring goods to the customer under the terms of a sales contract. As of June 30, 2018 and December 31, 2017, the Company recorded a deferred revenue liability of $62,481,147 and $43,087,473, respectively, which was presented as “Deposits received from customers” on the accompanying consolidated balance sheets. During the six months ended June 30, 2018 and 2017, the Company recognized $14,254,794 and $6,617,003, respectively, of deferred revenue included in the opening balances of deposits received from customers. The amounts were included in sales on the accompanying consolidated statements of income and comprehensive income (loss).

 

  19  

 

 

NOTE N - INCOME TAXES

 

In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted into law and the new legislation contains several key tax provisions that affected the Company, including, among others, a reduction of the federal corporate income tax rate to 21% effective January 1, 2018, and a recognition of the U.S. corporate income tax based on the deemed repatriation to the United States of the Company’s share of previously deferred earnings of certain non-U.S. subsidiaries of the Company upon enactment of the 2017 Tax Act. The Company is required to recognize the effect of the 2017 Tax Act in the period of enactment. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), Income Tax Accounting Implications of the 2017 Tax Act, which allows the Company to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. The Company is evaluating the impact of the 2017 Tax Act, however, as of the filing date, the Company was unable to determine a reasonable provision of the tax effects of the 2017 Tax Act. Therefore, no provisional amounts have been recorded on the consolidated financial statements as of December 31, 2017 and for the six months ended June 30, 2018 in accordance with SAB 118.

 

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

 

In 2015, the Joint Venture was awarded the Chinese government's "High-Tech Enterprise" designation for a third time, which is valid for three years and it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017. As the “High-Tech Enterprise” designation expired in 2018, the Joint Venture is undergoing the re-assessment by the government and the Company estimates it is highly probable that the designation will be awarded and therefore the 15% tax rate is used for the six months ended June 30, 2018.

 

The reconciliation of the effective income tax rate of the Company to the statutory income tax rate in the PRC for the six months ended June 30, 2018 and 2017 is as follows:

 

    Six Months Ended
June 30, 2018
    Six Months Ended
June 30, 2017
 
US statutory income tax rate     21.00 %     35.00 %
Valuation allowance recognized with respect to the loss in the US company     -21.00 %     -35.00 %
China statutory income tax rate     25.00 %     25.00 %
Effects of income tax exemptions and reliefs     -10.00 %     -10.0 %
Effects of additional deduction allowed for R&D expenses     -3.43 %     -3.16 %
Effects of expenses not deductible for tax purposes     2.18 %     0.51 %
Other items     0.81 %     0.37 %
Effective tax rate     14.56 %     12.72 %

 

  20  

 

 

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. In the six months ended June 30, 2018 and 2017, there were no penalties and interest, which generally are recorded in the general and administrative expenses or in the tax expenses. The provisions for income taxes for the six months ended June 30, 2018 and 2017, respectively, are summarized as follows:

 

    Six Months Ended
June 30, 2018
    Six Months Ended
June 30, 2017
 
             
Current   $ 2,201,850     $ 2,610,023  
Deferred     642,343       (12,340 )
                 
Total   $ 2,844,193     $ 2,597,683  

 

NOTE O – OPERATING LEASE WITH RELATED PARTY

 

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

 

The lease expenses were $825,704 and $487,794 for the six months ended June 30, 2018 and 2017, respectively.

 

  21  

 

 

NOTE P - WARRANTY CLAIMS

 

Warranty claims were $1,828,168 and $1,416,614 for the six months ended June 30, 2018 and 2017, respectively. Warranty claims are included in selling and distribution expenses on the accompanying consolidated statements of income and comprehensive income (loss). Accrued warranty expenses are included in the balances of accrued expenses on the accompanying consolidated balance sheets. The movement of accrued warranty expenses for the six months ended June 30, 2018 was as follows:

 

Beginning balance at January 1, 2018   $ 6,576,895  
Aggregate increase for new warranties issued during current period     1,828,168  
Aggregate reduction for payments made and effect of exchange rate fluctuation     (1,155,096 )
         
Ending balance at June 30, 2018   $ 7,249,967  

 

NOTE Q – SEGMENT INFORMATION

 

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

 

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

 

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

 

    Six Month Ended June 30,  
    2018     2017  
             
NET SALES TO EXTERNAL CUSTOMERS                
Commercial vehicles brake systems   $ 187,578,450     $ 138,849,057  
Passenger vehicles brake systems     48,653,184       27,626,905  
                 
Net sales   $ 236,231,634     $ 166,475,962  
INTERSEGMENT SALES                
Commercial vehicles brake systems   $     $  
Passenger vehicles brake systems            
                 
Intersegment sales   $     $  
                 
GROSS PROFIT                
Commercial vehicles brake systems   $ 42,734,721     $ 38,696,045  
Passenger vehicles brake systems     21,895,035       7,022,562  
Gross profit   $ 64,629,756     $ 45,718,607  
Selling and distribution expenses     23,993,870       14,594,185  
General and administrative expenses     12,468,189       8,755,435  
Research and development expenses     8,922,358       4,536,659  
                 
                 
Other operating income, net     4,576,551       578,709  
                 
Income from operations     23,821,890       18,411,037  
                 
Interest income     2,299,844       22,025  
Government grants     743,525       113,304  
Other income     202,693       714  
Interest expenses     (6,883,127 )     (1,023,336 )
Exchange differences     489,922       (509,850 )
Other expenses     (1,145,085 )     (140,289 )
Income before income tax expense   $ 19,529,662     $ 16,873,605  
CAPITAL EXPENDITURE                
Commercial vehicles brake systems   $ 27,215,974     $ 24,631,178  
Passenger vehicles brake systems     6,496,986       4,930,415  
                 
Total   $ 33,712,960     $ 29,561,593  
DEPRECIATION AND AMORTIZATION                
Commercial vehicles brake systems   $ 4,650,734     $ 3,489,621  
Passenger vehicles brake systems     1,181,824       698,190  
                 
Total   $ 5,832,558     $ 4,187,811  

 

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    June 30, 2018     December 31, 2017  
       
TOTAL ASSETS                
Commercial vehicles brake systems   $ 557,314,122     $ 492,348,129  
Passenger vehicles brake systems     188,955,457       89,967,813  
                 
Total   $ 746,269,579     $ 582,315,942  

 

    June 30, 2018     December 31, 2017  
       
LONG LIVED ASSETS                
Commercial vehicles brake systems   $ 113,323,019     $ 106,779,681  
Passenger vehicles brake systems     38,421,784       19,512,076  
                 
Total   $ 151,744,803     $ 126,291,757  

 

NOTE R – CONTINGENCIES

 

(1) In May 2016, the Company, through its principal operating subsidiary, entered into a Purchase Agreement with Ruili Group, pursuant to which the Company agreed to exchange the land use rights and factory facilities located at No. 1169 Yumeng Road, Ruian Economic Development Zone, Ruian City, Zhejiang Province, China (the “Dongshan Facility”), purchased in 2007 from Ruili Group, plus RMB 501.00 million (approximately $76.50 million) in cash for the land use rights and factory facilities located at No. 2666 Kaifaqu Avenue, Ruian Economic Development Zone, Ruian City, Zhejiang Province, China (the “Development Zone Facility”). As of the filing date, the Company hasn’t obtained the land use rights certificate or the property ownership certificate for the building of the Development Zone Facility. The Company reserved the relevant tax amount of RMB 15,030,000 (approximately $2,300,205). This amount was determined based on a 3% tax rate on the consideration paid for the Development Zone Facility, which the Company considered as the most probable amount of tax liability.

  

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

 

(3) The information of lease commitments is provided in Note O.

 

(4) The information of guarantees and assets pledged is provided in Note E.

 

NOTE S – SUBSEQUENT   EVENTS

 

During the subsequent period, the Company obtained short term loans in the total amount of approximately $34,911,000 from Agricultural Bank of China and China Zheshang Bank. Interest rates for those loans ranged from 3.73% to 4.52% per annum. The maturity dates of the loans existing as of the filing date ranged from July 30, 2018 to July 3, 2019. The Company continuously pledged bank acceptance notes to obtain loans from Agricultural Bank of China and China Zheshang Bank.

 

In the same period, the Company repaid loan principals and interest expenses in the total amount of approximately $27,436,000 to Agricultural Bank of China, Bank of China and China Zheshang Bank.

 

  23  

 

 

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

 

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

 

FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q includes forward-looking statements. Any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Generally, the words “believe,” “anticipate,” “may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar expressions, or the negative thereof, or comparable terminology, are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including the matters set forth in this report or other reports or documents we file with SEC from time to time, which could cause actual results or outcomes to differ materially from those anticipated. Some of the factors that could cause actual results to differ include: our ability to effectively implement our business strategy; our ability to handle downward pricing pressures on our products; and our ability to accurately or effectively plan our production or supply needs. For a discussion of these and all other known risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, which is available on the SEC’s website at www.sec.gov. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to revise or update these forward-looking statements.

 

OVERVIEW

 

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

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

For a summary of our accounting policies and estimates, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the Year ended December 31, 2017.

 

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

 

  24  

 

 

Results of Operations

 

The following statements are about results of operations for the three and six months ended June 30, 2018 as compared to the three and six months ended June 30, 2017.

 

Sales  

 

    Three Months Ended     Three Months Ended  
    June 30, 2018     June 30, 2017  
    (U.S.  dollars in millions)  
       
Commercial Vehicle Brake Systems   $ 96.0       74.7 %   $ 77.5       84.5 %
Passenger Vehicle Brake Systems   $ 32.5       25.3 %   $ 14.3       15.5 %
                                 
Total   $ 128.5       100.0 %   $ 91.7       100.0 %

 

    Six Months Ended     Six Months Ended  
    June 30, 2018     June 30, 2017  
    (U.S.  dollars in millions)  
       
Commercial Vehicle Brake Systems   $ 187.6       79.4 %   $ 138.8       83.4 %
Passenger Vehicle Brake Systems   $ 48.6       20.6 %   $ 27.7       16.6 %
                                 
Total   $ 236.2       100.0 %   $ 166.5       100.0 %

 

The sales were $128.5 million and $91.7 million for the three months ended June 30, 2018 and 2017, respectively, an increase of $36.8 million or 40.1%. The sales were $236.2 million and $166.5 million for the six months ended June 30, 2018 and 2017, respectively, an increase of $69.7 million or 41.9%. The increase was mainly due to the increased sales of commercial vehicle brake systems.

 

The sales from commercial vehicle brake systems increased by $18.5 million or 23.9%, to $96.0 million for the second fiscal quarter of 2018, compared to $77.5 million for the same period of 2017. The sales from commercial vehicle brake systems increased by $48.8 million or 35.2%, to $187.6 million for the six months ended June 30, 2018, compared to $138.8 million for the six months ended June 30, 2017. Our high quality, low cost products continued to generate higher sales and further penetrated into the commercial vehicle market, which impacted the sales of the commercial vehicle brake systems.

 

The sales from passenger vehicle brake systems increased by $18.2 million or 127.3%, to $32.5 million for the second fiscal quarter of 2018, compared to $14.3 million for the same period of 2017. The sales from passenger vehicle brake systems increased by $20.9 million or 75.5%, to $48.6 million for the six months ended June 30, 2018, compared to $27.7 million for the same period of 2017. The increase was mainly due to the increase of passenger vehicle market.

 

A breakdown of the sales revenue for these markets for the second fiscal quarter of the 2018 and 2017, respectively, is set forth below:

 

    Three
Months
    Percent     Three
Months
    Percent        
    Ended     of     Ended     of        
    June 30,
2018
    Total
Sales
    June 30,
2017
    Total
Sales
    Percentage
Change
 
    (U.S. dollars in millions)        
             
China OEM market   $ 62.6       48.7 %   $ 46.4       50.6 %     35.0 %
China Aftermarket   $ 42.8       33.3 %   $ 25.1       27.4 %     70.5 %
International market   $ 23.1       18.0 %   $ 20.2       22.0 %     13.9 %
Total   $ 128.5       100.0 %   $ 91.7       100.0 %     40.1 %

 

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A breakdown of the sales revenues for China OEM markets, China aftermarket and international market for the six months ended June 30, 2018 and 2017, respectively, is set forth below:

 

    Six Months     Percent     Six Months     Percent        
    Ended     of     Ended     of        
    June 30,
2018
    Total
Sales
    June 30,
2017
    Total
Sales
    Percentage
Change
 
    (U.S. dollars in million)        
             
China OEM market   $ 114.4       48.4 %   $ 85.2       51.1 %     34.4 %
China Aftermarket   $ 80.9       34.2 %   $ 47.1       28.3 %     71.7 %
International market   $ 40.9       17.4 %   $ 34.2       20.6 %     19.5 %
Total   $ 236.2       100.0 %   $ 166.5       100.0 %     41.9 %

 

Considering the increase of the production and sales of the commercial vehicle market, our sales to the Chinese OEM market increased by 35.0%, from the second fiscal quarter of 2017, to $62.6 million. Our sales to the Chinese OEM market increased by 34.4% from the six months ended June 30, 2017 to $114.4 million for the six months ended June 30, 2018.

 

Our sales to the China aftermarket increased by $17.7 million or 70.5%, to $42.8 million for the second fiscal quarter of 2018, compared to $25.1 million for the same period of 2017. Our sales to the China aftermarket increased by $33.8 million or 71.7%, to $80.9 million for the six months ended June 30, 2018, compared to $47.1 million for the same period of 2017. The increased new vehicle sales in China and the expiration of OEM warranties helped to drive our aftermarket business. Accelerated urbanization and the Chinese government’s increased support for public transportation favor our expansion in the bus aftermarket. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets.

 

Our export sales increased by $2.9 million or 13.9%, to $23.1 million for the second fiscal quarter of 2018, as compared to $20.2 million for the same period of 2017. Our export sales increased by $6.7 million or 19.5%, to $40.9 million for the six months ended June 30, 2018, as compared to $34.2 million for the same period of 2017. The increase in export sales was mainly due to our broadened customer base.

 

Cost of Sales and Gross Profit

 

Cost of sales for the three months ended June 30, 2018 were $94.1 million, an increase of $27.0 million or 40.3% from $67.1 million for the three months ended June 30, 2017. Cost of sales for the six months ended June 30, 2018 were $171.6, an increase of $50.8 million or 42.1% from $120.8 million for the same period in 2017.

 

Our gross profit increased by 39.5% from $24.7 million for the three months ended June 30, 2017 to $34.4 million for the three month period ended June 30, 2018. Our gross profit increased by 41.4% from $45.7 million for the six months ended June 30, 2017 to $64.6 million for the same period of 2018.

 

  26  

 

 

Gross margin decreased to 26.8% from 26.9% for the three months period ended June 30, 2018 compared to 2017. Gross margin decreased to 27.4% from 27.5% for the six months ended June 30, 2018, as compared to the same period of 2017. To strengthen our competitiveness and increase our market share, we enhanced the price promotion for the six months ended June 30, 2018. We intend to focus in 2018 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, 2018 was $79.0 million, increase by 40.8% from $56.1 million for the same period last year. Cost of sales from commercial vehicle brake systems for the six months ended June 30, 2018 was $144.8 million, increase by 44.5% from $100.2 million for the same period of 2017. The gross profit from commercial vehicle brake systems decreased by 20.8% from $21.4 million for three month period ended June 30, 2017 to $17.0 million for the three month period ended June 30, 2018. The gross profit from commercial vehicle brake systems increased by 10.4% from $38.7 million for the six months ended June 30, 2017 to $42.7 million for the same period of 2018. Gross margin from commercial vehicle brake systems decreased to 17.7% from 27.6% for the three months period ended June 30, 2018 compared to the three months period ended June 30, 2017. Gross margin from commercial vehicle brake systems decreased to 22.8% from 27.9% for the six months period ended June 30, 2018 compared to the three months period ended June 30, 2017.

 

Cost of sales from passenger vehicle brake systems for the three months period ended June 30, 2018 was $15.1 million, increase by 37.3% from $11.0 million for the three month period ended June 30, 2017. Cost of sales from passenger vehicle brake systems for the six months ended June 30, 2018 was $26.8 million, increase by 30.1% from $20.6 million for the same period of 2017. The gross profit from passenger vehicle brake systems increased by 430.3% from $3.3 million for the three month period ended June 30, 2017 to $17.5 million for the three month period ended June 30, 2018. The gross profit from passenger vehicle brake systems increased by 212.9% from $7.0 million for the six months ended June 30, 2017 to $21.9 million for the same period ended June 30, 2018. Gross margin from passenger vehicle brake systems increased to 53.7% from 22.9% for the three months ended June 30, 2018 compared to the three months period ended June 30, 2017. Gross margin from passenger vehicle brake systems increased to 45.0% from 25.4% for the six months ended June 30, 2018, as compared with the same period in 2017.

 

Selling and Distribution Expenses

 

Selling and distribution expenses were $14.0 million for the three months ended June 30, 2018, as compared to $9.0 million for the same period of 2017, an increase of $5.0 million or 55.3%. Selling and distribution expenses were $24.0 million for the six months ended June 30, 2018, as compared to $14.6 million for the same period of 2017, an increase of $9.4 million or 64.4%. The increase was mainly due to increased packaging expenses, repair fees, and product warranty fees.

 

  27  

 

 

As a percentage of sales revenue, selling expenses increased to 10.9% for the three months ended June 30, 2018, as compared to 9.8% for the same period in 2017. As a percentage of sales revenue, selling expenses increased to 10.2% for the six months ended June 30, 2018, as compared to 8.8% for the same period in 2017.

 

General and Administrative Expenses

 

General and administrative expenses were $7.7 million for the three months ended June 30, 2018, as compared to $4.7 million for the same period of 2017, an increase of $3.0 million or 63.4%. General and administrative expenses were $12.5 million for the six months ended June 30, 2018, as compared to $8.8 million for the same period of 2017, an increase of $3.7 million or 42.4%. The increase was mainly due to the increase of bad debt expense and employee salaries for the six months ended June 30, 2018.

 

As a percentage of sales revenue, general and administrative expenses increased to 6.0% for the three months ended June 30, 2018, as compared to 5.1% for the same period in 2017. As a percentage of sales revenue, general and administrative expenses were both 5.3% for the six months ended June 30, 2018, and for the same period in 2017.

 

Research and Development Expenses

 

Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development costs. For the three months ended June 30, 2018, research and development expenses were $5.3 million, as compared to $2.5 million for the same period of 2017, an increase of $2.8 million. For the six months ended June 30, 2018, research and development expenses were $8.9 million, as compared to $4.5 million for the same period of 2017, an increase of $4.4 million.

 

Other Operating Income

 

Other operating income was $2.4 million for the three months ended June 30, 2018, as compared to $0.3 million for the three months ended June 30, 2017, an increase of $2.1 million. Other operating income was $4.6 million for the six months ended June 30, 2018, as compared to $0.6 million for the six months ended June 30, 2017, an increase of $4.0 million. The increase was mainly due to an increase in sales of raw material scraps.

 

  28  

 

 

Depreciation and Amortization

 

Depreciation and amortization expense increased to $3.0 million for the three months ended June 30, 2018, compared with that of $2.2 million for the same period of 2017, an increase of $0.8 million. Depreciation and amortization expenses increased to $5.8 million for the six months ended June 30, 2018, compared with that of $4.2 million for the same period of 2017, an increase of $1.6 million. The increase was mainly due to some new addition in PPE and the purchase of land in the third quarter of 2017.

 

Interest income

 

The interest income for the three months ended June 30, 2018, increased to $0.8 million, compared with the same period of 2017. The interest income for the six months ended June 30, 2018, increased to $2.3 million, compared with the same period of 2017, mainly due to increased interest income from advances to related parties during the period.

 

Interest Expenses

 

The interest expenses for the three months ended June 30, 2018, increased by $3.0 million to $3.5 million from $0.5 million for the same period of 2017. The interest expenses for the six months ended June 30, 2018, increased by $5.9 million to $6.9 million from $1.0 million for the same period of 2017, mainly due to increased interest rate and increased amount of average loans outstanding during the period.

 

Income Tax

 

In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted into law and the new legislation contains several key tax provisions that affected the Company, including, among others, a reduction of the federal corporate income tax rate to 21% effective January 1, 2018, and a recognition of the U.S. corporate income tax based on the deemed repatriation to the United States of the Company’s share of previously deferred earnings of certain non-U.S. subsidiaries of the Company upon enactment of the 2017 Act. The Company is required to recognize the effect of the 2017 Tax Act in the period of enactment. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), Income Tax Accounting Implications of the 2017 Tax Cuts and Jobs Act, which allows the Company to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. The Company is proactively evaluating the impact of the Tax Act, however, as of the filing date, the Company was unable to determine a reasonable provision of the tax effects of the Tax Act. Therefore, no provisional amounts have been recorded on the consolidated financial statements as of December 31, 2017 and for the six months ended June 30, 2018 in accordance with SAB 118.

 

  29  

 

 

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

 

In 2015, the Joint Venture was awarded the Chinese government's "High-Tech Enterprise" designation for a third time, which is valid for three years and it continues to be taxed at the 15% tax rate in 2015, 2016 and 2017. As the “High-Tech Enterprise” designation expired in 2018, the Joint Venture is undergoing the re-assessment by the government and the Company estimates it is highly probable that the designation will be awarded and therefore the 15% tax rate is used for the six months ended June 30, 2018.

 

Income tax expense was $1.2 million for the three months ended June 30, 2018, as compared to $1.3 million for the three months ended June 30, 2017. Income tax expense was $2.8 for the six months ended June 30, 2018, as compared to $2.6 for the six months ended June 30, 2017.

 

Net Income Attributable to Non-Controlling Interest in Subsidiaries

 

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH, in each case held by our joint venture partners. On December 15, 2015, the Company disposed of its entire 60% equity interest in SIH. Net income attributable to noncontrolling interest in subsidiaries amounted to $0.7 million for the second fiscal quarter ended June 30, 2018 and 2017. Net income attributable to non-controlling interest in subsidiaries amounted to $1.7 million and $1.4 million for the six months ended June 30, 2018 and 2017, respectively.

 

Net Income Attributable to Stockholders

 

The net income attributable to stockholders for the fiscal quarter ended June 30, 2018, increased by $0.8 million, to $6.7 million from $5.9 million for the fiscal quarter ended June 30, 2017 due to the factors discussed above. The net income attributable to stockholders for the six months ended June 30, 2018, increased by $2.2 million, to $15.0 million from $12.8 million for the six months ended June 30, 2017 due to the factors discussed above. Earnings per share (“EPS”), both basic and diluted, for the fiscal quarter ended June 30, 2018 and 2017, were $0.35 and $0.31, respectively. EPS, both basic and diluted, for the six months ended June 30, 2018 and 2017, were $0.78 and $0.67, respectively.

 

  30  

 

 

FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

As of June 30, 2018, the Company had cash, cash equivalents, and restricted cash of $76.4 million, as compared to cash, cash equivalents, and restricted cash of $4.6 million as of December 31, 2017. The Company had working capital of $87.4 million at June 30, 2018, as compared to working capital of $111.4 million at December 31, 2017, reflecting current ratios of 1.2:1 and 1.3:1, respectively.

 

OPERATING - Net cash provided in operating activities was $66.1 million for six months ended June 30, 2018. For the same period in 2017, net cash used in operating activities was $3.2 million. Such change was primarily due to the increased cash inflow resulted by changes in accounts payable and bank acceptance notes to vendors.

 

INVESTING - During the six months ended June 30, 2018, the Company used net cash of $1.8 million in investing activities mainly for advances to related parties. For the six months ended June 30, 2017, the Company used net cash of $29.6 million in investing activities.

 

FINANCING - During the six month period ended June 30, 2018, the cash provided by financing activities was $9.8 million. Cash provided in financing activities was $27.2 million for the six months ended June 30, 2017. Such decrease was primarily due to the repayments to related parties and repayments of long term loans.

 

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

 

OFF-BALANCE SHEET ARRANGEMENTS

 

As of June 30, 2018, we did not have any material commitments for capital expenditures or have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.

 

According to the laws of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. In 2007, the Company purchased the land use rights from the Ruili Group, a related party. The Company also purchased the buildings on the land in the same transaction. The purchase price of land use right and building amounted to approximately $20 million. On May 5, 2016, the Company entered into a Purchase Agreement with the Ruili Group through Ruian, pursuant to which the Company agreed to exchange the Dongshan Facility plus RMB501 million (approximately $76.5 million) in cash for Development Zone Facility. The value of the Dongshan Facility and Development Zone Facility was appraised to be RMB 125 million (approximately $19.1 million) and RMB 626 million (approximately $95.6 million), respectively. As of June 30, 2018, total amount of RMB481 million (approximately $73.5 million) was paid to the Ruili Group in installments, and the remaining RMB20 million (approximately $3.0 million) will be paid within 10 days of completion of the required procedures for transferring the title of the facilities and the land use right as specified in the Purchase Agreement.

 

  31  

 

 

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

 

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

 

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

 

a)        The Ruili Group promised that the Company has the right to use the land and related building, even before the land use certificate is transferred.

 

b)       According to the laws of China, the government owns all the land and the buildings attached to the land in China. Once the land use right is granted to Ruili Group, Ruili Group has the right to assign its land use rights to any third parties, including the Company, without interference from the government. Therefore, it is unlikely that the government will oppose the Company’s right to use the land and related building.

 

c)       The Company has reserved tax payables in the amount of RMB 19,007,341 (approximately US$2,872.675) on its consolidated balance sheets under the line item “accrued expenses” as if no reduction or exemption of tax is approved. This amount was determined based on a 3% tax rate on the consideration paid for the land use right in the transaction, which the Company considered as the most probable amount of tax liability. This amount also represented the maximum amount of tax the Company expects to pay if the negotiation with the local government ultimately is not successful.

 

  32  

 

 

CONTRACTUAL OBLIGATIONS

 

As of June 30, 2018, we had no material changes outside the ordinary course of business in our contractual obligations.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures:

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs. As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of June 30, 2018 was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(b) and 15d-15(b) of the Exchange Act). Based on this evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures, as of June 30, 2018, were effective, in all material respects, for the purpose stated above.

 

Changes in Internal Control over Financial Reporting:

 

There were no changes in the Company’s internal control over financial reporting during the three months ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

  33  

 

 

PART II OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS 

 

None. 

 

ITEM 1A. RISK FACTORS 

 

Not applicable. 

 

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

 

None. 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES 

 

None. 

 

ITEM 4. MINE SAFETY DISCLOSURES 

 

Not applicable. 

 

ITEM 5. OTHER INFORMATION 

 

None.

 

 

  34  

 

 

ITEM 6. EXHIBITS

 

3.1 Amended and Restated Articles of Incorporation, as further amended (approved May 27, 2010). (1)
   
3.2 Amended and Restated Bylaws effective as of March 14, 2009. (2)
   
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (3)

 

101.1NS XBRL Instance Document
   
101.SCH XBRL Taxonomy Extension Schema Document
   
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
   
101.DEF XBRL Taxonomy Extension Definitions Linkbase Document
   
101.LAB XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

  

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

 

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

 

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

 

  35  

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated : August 14, 2018 SORL AUTO PARTS, INC.
   
  By: /s/ Xiao Ping Zhang
   
  Name: Xiao Ping Zhang
  Title: Chief Executive Officer
  (Principal Executive Officer)
   
  By: /s/ Zong Yun Zhou
   
  Name: Zong Yun Zhou
  Title: Chief Financial Officer 
  (Principal Accounting Officer)

 

  36  

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