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, 2008 |
o | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT |
For the transition period from _________ to _________
Commission file number 000-11991
SORL AUTO PARTS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE | 30-0091294 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
No. 1169 Yumeng Road
Ruian Economic Development District
Ruian City, Zhejiang Province, Zip: 325200
People’s Republic Of China
(Address of principal executive offices)
(Registrant’s telephone number)
Yes x No o
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 o | Accelerated Filer o | Non-Accelerated Filer o | Smaller Reporting Company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
Yes o No x
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the registrant classes of common equity, as of the latest practicable date:
As of June 30, 2008 there were 18,279,254 shares of Common Stock outstanding
SORL AUTO PARTS, INC.
FORM 10-Q
For the Quarter Ended June 30, 2008
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SORL Auto Parts, Inc. and Subsidiaries | |||||
June 30, 2008 (unaudited) and December 31, 2007 |
Jun 30, 2008 | December 31, 2007 | ||||||
(Unaudited) | (Audited) | ||||||
Assets | |||||||
Current Assets | |||||||
Cash and Cash Equivalents | US$ | 4,481,177 | US$ | 4,340,211 | |||
Accounts Receivable, Net of Provision | 38,862,983 | 30,586,239 | |||||
Notes Receivable | 12,805,169 | 9,410,385 | |||||
Inventory | 13,531,271 | 8,220,373 | |||||
Prepayments | 3,309,421 | 1,336,212 | |||||
Other Current Assets | 2,259,417 | 4,275,294 | |||||
Total Current Assets | 75,249,438 | 58,168,714 | |||||
Fixed Assets | |||||||
Property, Plant and Equipment | 30,828,160 | 27,889,182 | |||||
Less: Accumulated Depreciation | (7,676,656 | ) | (6,094,229 | ) | |||
Property, Plant and Equipment, Net | 23,151,504 | 21,794,953 | |||||
Land Use Rights, Net | 14,627,491 | 13,889,705 | |||||
Other Assets | |||||||
Deferred Compensation Cost-Stock options | 39,753 | 69,571 | |||||
Intangible Assets | 160,770 | 76,150 | |||||
Less: Accumulated Amortization | (31,250 | ) | (25,116 | ) | |||
Intangible Assets, Net | 129,520 | 51,034 | |||||
Total Other Assets | 169,273 | 120,605 | |||||
Total Assets | US$ | 113,197,706 | US$ | 93,973,977 | |||
Liabilities and Shareholders' Equity | |||||||
Current Liabilities | |||||||
Accounts Payable and Notes Payable | 8,013,208 | 5,305,172 | |||||
Deposit Received from Customers | 3,557,350 | 2,079,946 | |||||
Short Term Bank Loans | 1,990,622 | 3,370,328 | |||||
Income Tax Payable | 732,316 | 373,769 | |||||
Accrued Expenses | 3,234,970 | 1,859,938 | |||||
Other Current Liabilities | 487,979 | 463,563 | |||||
Total Current Liabilities | 18,016,445 | 13,452,716 | |||||
Minority Interest | 9,493,164 | 8,024,152 | |||||
Shareholders' Equity | |||||||
Common Stock - $0.002 Par Value; 50,000,000 authorized, | |||||||
18,279,254 Issued and Outstanding as of | |||||||
June 30, 2008 and December 31, 2007 respectively | 36,558 | 36,558 | |||||
Additional Paid In Capital | 37,498,452 | 37,498,452 | |||||
Reserves | 2,661,841 | 1,882,979 | |||||
Accumulated Other Comprehensive Income | 10,355,764 | 5,432,189 | |||||
Retained Earnings | 35,135,482 | 27,646,931 | |||||
85,688,097 | 72,497,109 | ||||||
Total Liabilities and Shareholders' Equity | US$ | 113,197,706 | US$ | 93,973,977 | |||
The accompanying notes are an integral part of these financial statements |
SORL Auto Parts, Inc. and Subsidiaries | ||||||||||||
For The Three Months and Six Months Ended June 30, 2008 and 2007 |
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||
Sales | US$ | 42,186,119 | 29,189,572 | 72,844,561 | 53,606,561 | ||||||||
Cost of Sales | 30,776,773 | 22,829,287 | 52,793,354 | 41,555,339 | |||||||||
Gross Profit | 11,409,346 | 6,360,285 | 20,051,207 | 12,051,222 | |||||||||
Expenses: | |||||||||||||
Selling and Distribution Expenses | 2,771,803 | 1,331,643 | 4,611,078 | 2,515,290 | |||||||||
General and Administrative Expenses | 2,718,217 | 1,027,436 | 4,694,418 | 2,720,623 | |||||||||
Financial Expenses | 383,320 | 114,268 | 752,996 | 257,436 | |||||||||
Total Expenses | 5,873,340 | 2,473,347 | 10,058,492 | 5,493,349 | |||||||||
Operating Income | 5,536,006 | 3,886,938 | 9,992,715 | 6,557,873 | |||||||||
Other Income | 222,762 | 351,932 | 333,840 | 384,272 | |||||||||
Non-Operating Expenses | (175,785 | ) | (80,550 | ) | (254,963 | ) | (84,639 | ) | |||||
Income (Loss) Before Provision for Income Taxes | 5,582,983 | 4,158,320 | 10,071,592 | 6,857,506 | |||||||||
Provision for Income Taxes | 318,757 | (422,721 | ) | 882,231 | (60,256 | ) | |||||||
Net Income Before Minority Interest | |||||||||||||
& Other Comprehensive Income | US$ | 5,264,226 | 4,581,041 | 9,189,361 | 6,917,762 | ||||||||
Minority Interest | 527,929 | 461,930 | 921,948 | 697,119 | |||||||||
Net Income Attributable to Shareholders | 4,736,297 | 4,119,111 | 8,267,413 | 6,220,643 | |||||||||
Foreign Currency Translation Adjustment | 2,110,749 | 1,075,648 | 5,470,639 | 1,697,589 | |||||||||
Minority Interest's Share | 211,075 | 107,565 | 547,064 | 169,759 | |||||||||
Comprehensive Income (Loss) | 6,635,971 | 5,087,194 | 13,190,988 | 7,748,473 | |||||||||
Weighted average common share - Basic | 18,279,254 | 18,275,126 | 18,279,254 | 18,275,126 | |||||||||
Weighted average common share - Diluted | 18,287,764 | 18,322,260 | 18,288,958 | 18,328,526 | |||||||||
EPS - Basic | 0.26 | 0.23 | 0.45 | 0.34 | |||||||||
EPS - Diluted | 0.26 | 0.22 | 0.45 | 0.34 | |||||||||
The accompanying notes are an integral part of these financial statements
SORL Auto Parts, Inc. and Subsidiaries | ||||||||||||
For The Three Months and Six Months Ended June 30, 2008 and 2007 |
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||
Cash Flows from Operating Activities | |||||||||||||
Net Income | US$ | 4,736,297 | 4,119,111 | 8,267,413 | 6,220,643 | ||||||||
Adjustments to reconcile net income (loss) to net cash from operating activities: | |||||||||||||
Minority Interest | 527,929 | 461,930 | 921,948 | 697,119 | |||||||||
Bad Debt Expense | 10,450 | (234,154 | ) | 21,282 | 187,176 | ||||||||
Depreciation and Amortization | 674,504 | 370,097 | 1,329,059 | 710,394 | |||||||||
Stock-Based Compensation Expense | 14,909 | 38,110 | 29,818 | 53,019 | |||||||||
Loss on disposal of Fixed Assets | 2,519 | 2,519 | 1,108 | ||||||||||
Changes in Assets and Liabilities: | |||||||||||||
Account Receivables | (2,142,593 | ) | (2,100,597 | ) | (6,092,371 | ) | (4,634,961 | ) | |||||
Notes Receivables | (2,102,462 | ) | (1,237,625 | ) | (2,731,319 | ) | (5,615,402 | ) | |||||
Other Currents Assets | (165,931 | ) | (680,963 | ) | 2,181,644 | (912,057 | ) | ||||||
Inventory | (2,164,427 | ) | (2,426,343 | ) | (4,642,399 | ) | (2,694,515 | ) | |||||
Prepayments | (712,009 | ) | 1,413,829 | (1,828,836 | ) | 3,332,649 | |||||||
Accounts Payable and Notes Payable | 418,290 | 2,060,032 | 2,276,580 | 991,030 | |||||||||
Income Tax Payable | 218,643 | 64,855 | 358,547 | 72,614 | |||||||||
Deposits Received from Customers | 828,703 | (4,080 | ) | 1,311,351 | 282,352 | ||||||||
Other Current Liabilities and Accrued Expenses | 1,220,975 | (255,848 | ) | 1,203,937 | (385,245 | ) | |||||||
Net Cash Flows from Operating Activities | 1,365,797 | 1,588,354 | 2,609,173 | (1,694,076 | ) | ||||||||
Cash Flows from Investing Activities | |||||||||||||
Acquisition of Property and Equipment | (552,037 | ) | (3,271,641 | ) | (1,109,428 | ) | (5,335,361 | ) | |||||
Investment in Intangible Assets | (78,109 | ) | — | (78,737 | ) | (19,915 | ) | ||||||
Net Cash Flows from Investing Activities | (630,146 | ) | (3,271,641 | ) | (1,188,165 | ) | (5,355,276 | ) | |||||
Cash Flows from Financing Activities | |||||||||||||
Proceeds from (Repayment of) Bank Loans | 930,359 | 1,492,936 | (1,502,107 | ) | 1,492,936 | ||||||||
Net Cash flows from Financing Activities | 930,359 | 1,492,936 | (1,502,107 | ) | 1,492,936 | ||||||||
Effects on changes in foreign exchange rate | 82,357 | 89,213 | 222,065 | 170,257 | |||||||||
Net Change in Cash and Cash Equivalents | 1,748,367 | (101,138 | ) | 140,966 | (5,386,159 | ) | |||||||
Cash and Cash Equivalents- Beginning of the year | 2,732,810 | 5,852,480 | 4,340,211 | 11,137,501 | |||||||||
Cash and cash Equivalents - End of the period | US$ | 4,481,177 | 5,751,342 | 4,481,177 | 5,751,342 | ||||||||
Supplemental Cash Flow Disclosures: | |||||||||||||
Interest Paid | 77,081 | 12,914 | 103,125 | 12,914 | |||||||||
Tax Paid | 505,146 | 495,257 | 2,388,521 | 853,436 | |||||||||
The accompanying notes are an integral part of these financial statements
SORL Auto Parts, Inc. and Subsidiaries | ||||||||
Three Months Ended June 30, 2008 and 2007 |
Number | Common | Additional | Reserves | Retained | Accumu. Other | ||||||||||||||||||||
of Share | Stock | Paid-in | Earnings | Comprehensive | Shareholders' | Minority | |||||||||||||||||||
Capital | (Deficit) | Income | Equity | Interest | |||||||||||||||||||||
Beginning Balance - April 1, 2007 | 18,275,126 | 36,550 | 37,444,051 | 1,008,786 | 19,878,625 | 1,662,216 | 60,030,228 | 6,633,940 | |||||||||||||||||
Net Income | — | — | — | — | 4,119,111 | — | 4,119,111 | 461,930 | |||||||||||||||||
Other Comprehensive Income | — | — | — | — | — | 968,083 | 968,083 | 107,565 | |||||||||||||||||
Transfer to reserve | — | — | — | 415,737 | (415,737 | ) | — | — | — | ||||||||||||||||
4,128 options issued | — | — | 23,201 | — | — | 23,201 | — | ||||||||||||||||||
Ending Balance - June 30, 2007 | 18,275,126 | 36,550 | 37,467,252 | 1,424,523 | 23,581,999 | 2,630,299 | 65,140,623 | 7,203,435 | |||||||||||||||||
Beginning Balance - April 1, 2008 | 18,279,254 | 36,558 | 37,498,452 | 2,237,597 | 30,823,429 | 8,456,090 | 79,052,126 | 8,754,160 | |||||||||||||||||
Net Income | — | — | — | — | 4,736,297 | — | 4,736,297 | 527,929 | |||||||||||||||||
Other Comprehensive Income | — | — | — | — | — | 1,899,674 | 1,899,674 | 211,075 | |||||||||||||||||
Transfer to reserve | — | — | — | 424,244 | (424,244 | ) | — | — | — | ||||||||||||||||
— | — | — | — | — | — | — | — | ||||||||||||||||||
Ending Balance - June 30, 2008 | 18,279,254 | 36,558 | 37,498,452 | 2,661,841 | 35,135,482 | 10,355,764 | 85,688,097 | 9,493,164 | |||||||||||||||||
Six Months Ended June 30, 2008 and 2007 |
Number | Common | Additional | Reserves | Retained | Accumu. Other | ||||||||||||||||||||
of Share | Stock | Paid-in | Earnings | Comprehensive | Shareholders' | Minority | |||||||||||||||||||
Capital | (Deficit) | Income | Equity | Interest | |||||||||||||||||||||
Beginning Balance - January 1, 2007 | 18,275,126 | 36,550 | 37,444,051 | 797,116 | 17,988,763 | 1,102,469 | 57,368,949 | 6,336,557 | |||||||||||||||||
Net Income | — | — | — | — | 6,220,643 | 6,220,643 | 697,119 | ||||||||||||||||||
Other Comprehensive Income | — | — | — | — | — | 1,527,830 | 1,527,830 | 169,759 | |||||||||||||||||
Transfer to reserve | — | — | — | 627,407 | (627,407 | ) | — | — | — | ||||||||||||||||
4,128 options issued | — | — | 23,201 | — | — | — | 23,201 | — | |||||||||||||||||
Ending Balance - June 30, 2007 | 18,275,126 | 36,550 | 37,467,252 | 1,424,523 | 23,581,999 | 2,630,299 | 65,140,623 | 7,203,435 | |||||||||||||||||
Beginning Balance - January 1, 2008 | 18,279,254 | 36,558 | 37,498,452 | 1,882,979 | 27,646,931 | 5,432,189 | 72,497,109 | 8,024,152 | |||||||||||||||||
�� | |||||||||||||||||||||||||
Net Income | — | — | — | — | 8,267,413 | 8,267,413 | 921,948 | ||||||||||||||||||
Other Comprehensive Income | — | — | — | — | — | 4,923,575 | 4,923,575 | 547,064 | |||||||||||||||||
Transfer to reserve | — | — | — | 778,862 | (778,862 | ) | — | — | — | ||||||||||||||||
4,128 options issued | — | — | — | — | — | — | — | — | |||||||||||||||||
Ending Balance - June 30, 2008 | 18,279,254 | 36,558 | 37,498,452 | 2,661,841 | 35,135,482 | 10,355,764 | 85,688,097 | 9,493,164 | |||||||||||||||||
The accompanying notes are an integral part of these financial statements
NOTE A - DESCRIPTION OF BUSINESS
SORL Auto Parts, Inc. (the “Company”) is principally engaged in the manufacture and distribution of automotive air brake valves and related components for commercial vehicles weighing more than three tons, such as trucks and buses, through its 90% ownership of Ruili Group Ruian Auto Parts Company Limited (the “Joint Venture”) in the People’s Republic of China (“PRC” or “China”). The Company distributes products both in China and internationally under the SORL trademarks. The Company’s product range includes approximately 40 categories of brake valves with over 1000 different specifications.
NOTE B - BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated in the consolidation. Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted as permitted by the rules and regulations of the United States Securities and Exchange Commission, although the Company believes that the disclosures contained in this report are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K 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.
NOTE C - RECENTLY ISSUED FINANCIAL STANDARDS
In September 2006, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No.157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. On February 12, 2008, the FASB issued FASB Staff Position (FSP) No.157-2, which deferred the effective date for certain portions of SFAS No.157 related to nonrecurring measurements of nonfinancial assets and liabilities. The provision of SFAS No.157 will be effective for the Company’s fiscal year 2009.
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of SFAS No.115", which allows for the option to measure financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The adoption of SFAS No. 159 has not had a material impact on the Company's consolidated results of operations or financial position.
In December 2007, the FASB issued FASB 141(R), "Business Combinations" the objective of which is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. The new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination.
In December 2007, the FASB issued FASB 160 "Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No.51" of which the objective is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards by requiring all entities to report noncontrolling (minority) interests in subsidiaries in the same way - as an entity in the consolidated financial statements. Moreover, Statement 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring that they be treated as equity transactions.
Both FASB 141(R) and FASB 160 are effective for fiscal years beginning after December 15, 2008. The Company does not believe that the adoption of these standards will have any impact on its financial statements.
In December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB 110”). SAB 110 permits companies to continue to use the simplified method, under certain circumstances, in estimating the expected term of “plain vanilla” options beyond December 31, 2007. SAB 110 updates guidance provided in SAB 107 that previously stated that the Staff would not expect a company to use the simplified method for share option grants after December 31, 2007. Adoption of SAB 110 is not expected to have a material impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued SFAS No.161, Disclosures about Derivative Instruments and Hedging Activities- an amendment of FASB statement No.133.SFAS No.161 requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS No.161 is effective for fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008, with early application encouraged. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ending December 31, 2009. The Company is currently evaluating the impact of SFAS No. 161 on its financial statements.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles.” SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company is currently evaluating the impact of SFAS 162 on its consolidated financial statements but does not expect it to have a material effect.
Also in May 2008, the FASB issued SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60" (“SFAS 163”). SFAS 163 interprets Statement 60 and amends existing accounting pronouncements to clarify their application to the financial guarantee insurance contracts included within the scope of that Statement. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2009. The Company is currently evaluating the impact of SFAS 163 on its consolidated financial statements but does not expect it to have a material effect.
NOTE D - RELATED PARTY TRANSACTIONS
The Company continued to purchase non-valve automotive components and packaging materials from the Ruili Group Co., Ltd., which is the minority shareholder of the Joint Venture, and which also has a common controlling party with the Company, the Zhang family.
The following related party transactions are reported for the three months and six months ended June 30, 2008 and 2007:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||
PURCHASES FROM: | |||||||||||||
Ruili Group Co., Ltd. | $ | 10,649,765 | $ | 7,300,184 | $ | 19,153,909 | $ | 12,678,779 | |||||
Total | $ | 10,649,765 | $ | 7,300,184 | $ | 19,153,909 | $ | 12,678,779 | |||||
SALES TO: | |||||||||||||
Ruili Group Co., Ltd. | $ | 1,004,231 | $ | — | $ | 1,822,149 | $ | 914,683 | |||||
Total | $ | 1,004,231 | $ | — | $ | 1,822,149 | $ | 914,683 |
The total purchases from Ruili Group during the three months ended June 30, 2008 consisted of $10.3 million of finished products for non-valve auto parts and $ 0.3 million of packaging materials. During the six months ended June 30, 2008, the breakdown was $16.3 million of finished products of non-valve auto parts, $2.2 million of components for non-valve auto parts and approximately $0.6 million of packaging materials
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
ACCOUNTS PAYABLE | |||||||
Ruili Group Co., Ltd. | $ | 3,453,244 | $ | 97,503 | |||
Total | $ | 3,453,244 | $ | 97,503 | |||
OTHER CURRENT ASSETS | |||||||
Ruili Group Co., Ltd. | $ | — | $ | 1,761,007 | |||
Total | $ | — | $ | 1,761,007 |
NOTE E - ACCOUNTS RECEIVABLE
The changes in the allowance for doubtful accounts at June 30, 2008 and December 31, 2007 were summarized as follows:
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Beginning balance | $ | 27,987 | $ | 8,769 | |||
Add: Increase to allowance | 3,309 | 19,218 | |||||
Less: Accounts written off | |||||||
Ending balance | $ | 31,296 | $ | 27,987 |
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Accounts receivable | $ | 38,894,279 | $ | 30,614,226 | |||
Less: allowance for doubtful accounts | (31,296 | ) | (27,987 | ) | |||
Account receivable balance, net | $ | 38,862,983 | $ | 30,586,239 |
NOTE F - INVENTORIES
On June 30, 2008 and December 31, 2007, inventories consisted of the following:
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Raw Material | $ | 3,419,860 | $ | 2,354,637 | |||
Work in process | 698,483 | 4,157,643 | |||||
Finished Goods | 9,412,928 | 1,708,093 | |||||
Total Inventory | $ | 13,531,271 | $ | 8,220,373 |
NOTE G - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following, on June 30, 2008 and December 31, 2007:
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Machinery | $ | 20,150,149 | $ | 18,118,125 | |||
Molds | 1,271,005 | 1,193,488 | |||||
Office equipment | 486,988 | 358,163 | |||||
Vehicle | 973,256 | 757,311 | |||||
Building | 7,946,761 | 7,462,096 | |||||
Construction In Progress | |||||||
Sub-Total | 30,828,160 | 27,889,182 | |||||
Less: Accumulated depreciation | (7,676,656 | ) | (6,094,229 | ) | |||
Fixed Assets, net | $ | 23,151,504 | $ | 21,794,953 |
Depreciation expense charged to operations was $1,164,736 and $707,617 for the six months ended June 30, 2008 and 2007, respectively.
NOTE H- LAND USE RIGHTS
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Cost: | $ | 14,874,021 | $ | 13,966,870 | |||
Less: Accumulated amortization: | 246,531 | 77,165 | |||||
Land use rights, net | $ | 14,627,491 | $ | 13,889,705 |
According to the law of China, the government owns all the land in China. Companies and individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. The Company purchased the land use rights from Ruili Group for approximately $13.9 million on September 28, 2007. The Company has not yet obtained the land use right certificate in the Company’s name, from the Chinese government. The Company is in the process of applying to obtain the land use right certificate. Amortization expenses were $159,934 for the six months ended June 30, 2008.
NOTE I - INTANGIBLE ASSETS
Intangible assets owned by the Company included patent technology and management software licenses. Gross intangible assets were $ 160,770, less accumulated amortization of $31,250 for net intangible assets of $ 129,520 as of June 30, 2008. Gross intangible assets were $76,150, less accumulated amortization of $25,116 for net intangible assets of $51,034 as of December 31, 2007. Amortization expenses were $ 2,465 and $2,775 for the six months ended June 30, 2008 and 2007 respectively. Future estimated amortization expense is as follows:
2008 | 2009 | 2010 | 2011 | 2012 | Thereafter | ||||||||||
$ | 7,616 | $ | 15,231 | $ | 15,231 | $ | 15,231 | $ | 15,231 | $ | 60,979 |
NOTE J - PREPAYMENT
Prepayment consisted of the following as of June 30, 2008 and December 31, 2007:
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Raw material suppliers | $ | 2,643,620 | $ | 929,178 | |||
Equipment purchase | 665,801 | 407,035 | |||||
Total prepayment | $ | 3,309,421 | $ | 1,336,212 |
NOTE K - BANK LOANS
Bank loans represented the following as of June 30, 2008 and December 31, 2007:
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Secured | $ | 1,990,622 | $ | 3,370,328 | |||
Less: Current portion | $ | (1,990,622 | ) | $ | (3,370,328 | ) | |
Non-current portion | $ | — | $ | — |
NOTE L - ACCRUED EXPENSES
Accrued expenses consisted of the following as of June 30, 2008 and December 31, 2007:
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Accrued payroll | $ | 971,493 | $ | 601,733 | |||
Other accrued expenses | 2,263,477 | 1,258,205 | |||||
Total accrued expenses | $ | 3,234,970 | $ | 1,859,938 |
NOTE M - RESERVE
The reserve funds are comprised of the following:
June 30, | December 31, | ||||||
2008 | 2007 | ||||||
Statutory surplus reserve fund | $ | 2,661,841 | $ | 1,882,979 | |||
Total | $ | 2,661,841 | $ | 1,882,979 |
Pursuant to the relevant laws and regulations of Sino-foreign joint venture enterprises, the profits of the Company's subsidiary, which are based on the subsidiary’s PRC statutory financial statements, are available for distribution in the form of cash dividends after they have satisfied all the PRC tax liabilities, provided for losses in previous years, and made appropriations to reserve funds, as determined at the discretion of the subsidiary’s board of directors in accordance with PRC accounting standards and regulations.
As stipulated by the relevant laws and regulations for enterprises operating in the PRC, the Company's Sino-foreign joint venture is required to make annual appropriations to the statutory surplus funds. In accordance with the relevant PRC regulations and the articles of association of the respective companies, the Joint Venture is required to allocate a certain percentage of its profits after taxation, as determined in accordance with PRC accounting standards applicable to the Company, to the statutory surplus reserve until such reserve reaches 50% of the registered capital of the Company.
Net income as reported in the US GAAP financial statements differs from that as reported in the PRC statutory financial statements. Under the relevant laws and regulations in the PRC, the profits available for distribution are based on the statutory financial statements. If the Joint Venture has foreign currency available after meeting its operational needs, the Joint Venture may make its profit distributions in foreign currency to the extent foreign currency is available. Otherwise, it is necessary to obtain approval and convert such distributions at an authorized bank.
NOTE N - INCOME TAXES
There was no income tax expense for the fiscal year ended December 31, 2005 and 2004. As a result of the Joint Venture obtaining its Sino-foreign joint venture status in 2004, in accordance with applicable PRC tax regulations, the Joint Venture was exempted from PRC income tax in both fiscal 2004 and 2005. Thereafter, the Joint Venture is entitled to a tax concession of 50% of the applicable income tax rate for the three years ended December 31, 2006, 2007, and 2008. With the new PRC Enterprise Income Tax Law, taking effect on January 1, 2008, the Company is generally subject to a PRC income tax rate of 12.5%.
The reconciliation of the effective income tax rate of the Joint Venture to the statutory income tax rate in the PRC for the six months ended June 30, 2008 is as follows:
Statutory tax rate | 25.0 | % | ||
Tax holidays and concessions | -12.5 | % | ||
Effective tax rate | 12.5 | % |
No provision for deferred tax liabilities has been made, since the Joint Venture had no material temporary differences between the tax bases of assets and liabilities and their carrying amounts.
NOTE O - LEASES
In December 2006, the Joint Venture entered into a lease agreement with Ruili Group Co., Ltd. for the lease of two apartment buildings. These two apartment buildings are for the Joint Venture’s management personnel and staff, respectively. The lease term is from January 2007 to December 2011 for one of the apartment buildings and from January 2007 to December 2012 for the other.
Future minimum rental payments for the years ending December 31 are as follows:
2008 | 2009 | 2010 | 2011 | 2012 | Thereafter | |||||||||||||
Buildings | $ | 140,082 | $ | 280,163 | $ | 280,163 | $ | 280,163 | $ | 67,975 | $ | — | ||||||
Total | $ | 140,082 | $ | 280,163 | $ | 280,163 | $ | 280,163 | $ | 67,975 | $ | — |
NOTE P - ADVERTISING COSTS
Advertising costs were $ 4,261 and $586 for the six months ended June 30, 2008 and 2007, respectively.
NOTE Q - RESEARCH AND DEVELOPMENT EXPENSE
Research and development costs are expensed as incurred and were $1,736,962 and $ 553,672 for the six months ended June 30, 2008 and 2007, respectively.
NOTE R - WARRANTY CLAIMS
Warranty claims were $ 1,060,353 and $585,888 for the six months ended June 30, 2008 and 2007, respectively. The movement of accrued warranty expenses for the six months ended June 30, 2008 was as follows:
Beginning balance at Jan 01, 2008 | $ | 863,428 | ||
Accrued during the six months ended June 30, 2008: | $ | 1,060,353 | ||
Less: Actual Paid during the six months ended June 30, 2008: | $ | 706,863 | ||
Ending balance at June 30, 2008 | $ | 1,216,918 |
NOTE S - STOCK COMPENSATION PLAN
(1) The Company’s 2005 Stock Compensation Plan (the Plan) permits the grant of share options and shares to its employees for up to 1,700,000 shares of common stock. The Company believes that such awards better align the interests of its employees with those of its shareholders. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant.
Pursuant to the Plan, the Company issued 60,000 options with an exercise price of $4.79 per share on March 1, 2006. In accordance with the vesting provisions of the grants, the options will become vested and exercisable under the following schedule.
Number of Shares | % of Shares Issued | Initial Vesting Date | ||
60,000 | 100% | March 1, 2009 |
The Company accounts for stock-based compensation in accordance with SFAS No. 123R, “Share-Based Payment.” The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option-pricing model that uses the assumptions noted in the following table.
Dividend Yield | 0.00 | % | ||
Expected Volatility | 96.54 | % | ||
Risk-Free Interest Rate | 4.59 | % | ||
Contractual Term | 3 years | |||
Stock Price at Date of Grant | $ | 4.79 | ||
Exercise Price | $ | 4.79 |
The amortization of deferred stock-based compensation for these equity arrangements was $ 29,818 for the six months ended June 30, 2008. As of June 30, 2008, there was $ 39,753 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the plan. The cost is expected to be recognized over a period of 0.7 years.
A summary of option activity under the Plan as of June 30, 2008 and changes during the six months ended June 30, 2008 is as follows:
Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||||
January 1, 2006 | — | $ | — | — | $ | — | |||||||
Granted | 60,000 | 4.79 | 3 Years | — | |||||||||
Exercised | — | — | — | — | |||||||||
Forfeited | — | — | — | — | |||||||||
Outstanding at June 30, 2008 | 60,000 | $ | 4.79 | 0.7 Years | $ | 34,200 | |||||||
Exercisable at June 30, 2008 | — | — | — | — |
(ii). Subject to all the terms and provisions of the 2005 Stock Compensation Plan, on June 20, 2007, the Company granted to its previous senior manager of investor relations, David Ming He options to purchase 4,128 shares of its common stocks with an exercise price of $7.25 per share. The option became vested and exercisable immediately on the date thereof.
Number of Shares | % of Shares Issued | Initial Vesting Date | ||
4,128 | 100% | June 20, 2007 |
The Company accounts for stock-based compensation in accordance with SFAS No. 123R, “Share-Based Payment.” The fair value of each warrant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model that uses the assumptions noted in the following table.
Dividend Yield | 0.00 | % | ||
Expected Volatility | 141.47 | % | ||
Risk-Free Interest Rate | 5.14 | % | ||
Contractual Term | 3 years | |||
Stock Price at Date of Grant | $ | 7.09 | ||
Exercise Price | $ | 7.25 |
Total stock-based compensation expenses related to the 4,128 stock options granted amounted to $23,201. This amount is charged to G&A during fiscal year 2007.
A summary of option activity under the Plan as of June 30, 2008 and changes during the six months ended June 30, 2008 is as follows:
Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||||
January 1, 2007 | — | $ | — | — | $ | — | |||||||
Granted | 4,128 | $ | 7.25 | 3 Years | — | ||||||||
Exercised | — | — | — | — | |||||||||
Forfeited | — | — | — | — | |||||||||
Outstanding at June 30, 2008 | 4,128 | $ | 7.25 | 2 Years | $ | — | |||||||
Exercisable at June 30, 2008 | 4,128 | $ | 7.25 | 2 Years | $ | — |
(2) On January 5, 2006, the Company issued 100,000 warrants for financial services to be provided by Maxim Group LLC and Chardan Capital Markets, LLC, with an exercise price of $6.25 per share. In accordance with the common stock purchase warrant agreement, the warrants became vested and exercisable immediately on the date thereof. The Company’s agreements with Maxim Group LLC and Chardan Capital Markets, LLC have been terminated.
Number of Shares | % of Shares Issued | Initial Vesting Date | ||
100,000 | 100% | January 5, 2006 |
The Company accounts for these warrants in accordance with SFAS No. 123R, “Share-Based Payment.” The fair value of each warrant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model that uses the assumptions noted in the following table.
Dividend Yield | 0.00 | % | ||
Expected Volatility | 95.01 | % | ||
Risk-Free Interest Rate | 4.36 | % | ||
Contractual Term | 4 years | |||
Stock Price at Date of Grant | $ | 4.70 | ||
Exercise Price | $ | 6.25 |
Total deferred stock-based compensation expenses related to the 100,000 warrants granted amounted to $299,052. This amount is amortized over one year in a manner consistent with Financial Accounting Standards Board Interpretation No. 123 (R). The amortization of deferred stock-based compensation for these equity arrangements was $299,052 for the fiscal year ended December 31, 2006.
A summary of option activity with respect to the warrants as of June 30, 2008 and changes during the six months ended June 30, 2008 is as follows:
Warrants | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||||
January 1, 2006 | — | $ | — | — | $ | — | |||||||
Granted | 100,000 | $ | 6.25 | 4 Years | — | ||||||||
Exercised | — | — | — | — | |||||||||
Forfeited | — | — | — | — | |||||||||
Outstanding at June 30, 2008 | 100,000 | $ | 6.25 | 1.5 Years | $ | — | |||||||
Exercisable at June 30, 2008 | 100,000 | $ | 6.25 | 1.5 Years | $ | — |
NOTE T- COMMITMENTS AND CONTINGENCIES
Information regarding land use rights and lease commitments is provided in Notes H and O. |
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 financial statements, as well as information relating to the plans of our current management. This report includes forward-looking statements. Generally, the words “believes,” “anticipates,” “may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar expressions or the negative thereof or comparable terminology are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including the matters set forth in this report or other reports or documents we file with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those anticipated. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to update these forward-looking statements.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-Q.
OVERVIEW
The Company manufactures and distributes automotive air brake valves and related components in China and internationally for use primarily in vehicles weighing over three tons, such as trucks and buses. There are forty categories of valves with over one thousand different specifications. Management believes that it is the largest manufacturer of automotive brake valves in China.
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” in our Annual Report on Form 10-K for the Fiscal Year ended December 31, 2007.
See Note N to the attached Unaudited Consolidated Financial Statements for the information regarding changes in taxation by the government of China.
Results of Operations
(1) | Results of operations for the three months ended June 30, 2008 as compared to the three months ended June 30, 2007. |
SALES
Three Months ended | Three Months ended | ||||||||||||
30-Jun-08 | 30-Jun-07 | ||||||||||||
(U.S. dollars in millions) | |||||||||||||
Air brake valves & related components | $ | 31.6 | 75 | % | $ | 22.2 | 76 | % | |||||
Non-valve products | $ | 10.5 | 25 | % | $ | 7 | 24 | % | |||||
Total | $ | 42.1 | 100 | % | $ | 29.2 | 100 | % |
Sales consist of air brake valves and related components manufactured by SORL and sold to domestic original equipment manufacturers (OEM), aftermarket customers and export market as well as distribution of non-valve auto parts sourced from the Ruili Group.
Net sales were $42,186,119 and $ 29,189,572 for the three months ended June 30, 2008 and 2007, respectively. Compared with the same period of 2007, net sales for the three months ended June 30, 2008 increased by $13.0 million or 44.5% to $ 42.2 million. The increase in sales was a result of the increased demand for commercial vehicle parts in China and continued expansion of our export sales.
A breakdown of net sales revenue for these markets for the second quarter of the 2008 and 2007 fiscal years, respectively, is set forth below:
Three Months | Three Months | ||||||||||||
ended | ended | ||||||||||||
30-Jun-08 | % | 30-Jun-07 | % | ||||||||||
(U.S. dollars in millions) | |||||||||||||
China OEM market | $ | 17.5 | 42 | % | $ | 12 | 41 | % | |||||
China Aftermarket | $ | 10.5 | 25 | % | $ | 6.3 | 22 | % | |||||
International market | $ | 14.1 | 33 | % | $ | 10.9 | 37 | % | |||||
Total | $ | 42.1 | 100 | % | $ | 29.2 | 100 | % |
During the second quarter of 2008, the national transportation system in China was recovering from the impact caused by the significant snow storms occurred in the first two months of 2008. With the approaching of implementation of the China III emission standard beginning July 1, 2008, the consumption of trucks equipped with China II engines was significantly spurred before the policy was enforced, which in turn boosted the output and sales volume of vehicles made in China. As a result, our Chinese OEM sales achieved an approximately 45.8% year over year growth, increasing from $12.0 million in the second quarter of 2007 to $17.5 million.
However, we take a conservative view on whether the increased consumption of trucks will continue in the coming two quarters. We think that the additional costs required to achieve China III compliance will lead to higher vehicle prices, which will likely to discourage demand for various vehicles. Further, during 2008 Beijing Olympic Games period, our major customers, such as FAW Qiongdao, Beiqi Foton Zhucheng and Beiqi Foton Aumen will halt production due to the traffic control in the regions around Beijing. Consequently, our near-term OEM sales in the second half year might be cut back.
Due to our well established sales networks and our increased production capacity, the Company achieved total revenue of $10.5 million in the Chinese aftermarket sales for the three months ended June 30, 2008, an increase of $4.2 million, or 66.7% compared to the same period of last year.
Our export sales grew by $ 3.2 million or approximately 29.4% for the three months ended June 30, 2008, as compared to $10.9 million for the same period of 2007. This increase reflects the introduction of new products, the improvement in technological support, the expansion of the contract sales force and the implementation of a market plan focusing on the export market segment.
COST OF SALES
Cost of sales for the three months ended June 30, 2008 increased to $ 30,776,773 from $ 22,829,287 for the same period of 2007, a $ 7,947,486 or 34.8% increase, compared with total sales growth of 44.5% for the period.
GROSS PROFIT
From $6,360,285 for the second quarter of 2007 to $11,409,346 for the second quarter of 2008, our gross profit grew by 79.4%, exceeding our revenue growth rate. Therefore, gross margin increased 5.2% for the three months ended June 30, 2008, to 27.0% from 21.8 % for the same period of 2007.
The higher gross margin was the result of raising prices and cutting production costs. The Joint Venture continued to improve production methods in its manufacturing process. This has resulted in reducing the manufacturing cycle, reducing waste, and thereby reducing production cost. Also, favorable changes in product and market mix helped raise the average selling price of our products. For the Chinese OEM market, we have sold more system products as opposed to individual components. For the Chinese and the international aftermarkets, we have been able to pass part of our cost increases to the end users, largely due to an uptrend in the prices for truck parts from China. The successful expansion of our sales into the higher margin municipal bus market has also contributed to the gross margin improvement of the Joint Venture since the last quarter of 2007.
SELLING AND DISTRIBUTION EXPENSES
Selling and distribution expenses were $2,771,803 for the three months ended June 30, 2008, as compared to $ 1,331,643 for the same period of 2007, an increase of $ 1,440,160 or 108.1%.
Selling and distribution expenses include salaries and wages, transportation expense, packaging expense, warranty expense, expenses associated with traveling, advertising, promotions, trade shows and seminars, and other expenses. Selling and distribution expenses for the three months ended June 30, 2008 increased primarily due to these factors:
(1) | Increased transportation expense: During the second quarter of 2008, transportation costs increased by $601,609 as compared to $ 335,397 for the same period of 2007. The increase in transportation expense was mainly due to increased sales and the rise in the transportation cost resulted from the increased price of oil and the increased number of loads necessitated by the overloading control measures imposed by the Chinese government since the third quarter of 2007. |
(2) | Increased packaging expense: Packaging costs were $737,920 for the three months ended June 30, 2008, an increase of $274,166 as compared with the same period of 2007, which was consistent with the revenue growth. |
(3) | Increased product warranty expense. The Company recorded $612,994 of product warranty expenses for the three months ended June 30, 2008, as compared to $ 321,083 for the three months ended June 30, 2007, an increase of $291,911. |
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $ 2,718,217 for the three months ended June 30, 2008, as compared to $ 1,027,436 for the same period of 2007, an increase of $ 1,690,781 or 164.6 % mainly due to the following factors:
(1) | The expansion of economic activities, facilities and workforce resulted in increased depreciation, office expenses, staff salary, work insurance and welfare, travel expenses and other miscellaneous fees totaling an increase of $ 437,985 as compared to the same period of 2007. |
(2) | R&D expense, which is included in general and administrative expenses, increased by $936,867, as compared to $330,797 of R&D expense for the same period of 2007, as discussed below. |
(3) | During the three months ended June 30, 2007, the reversal of the bad debt provision resulted in a negative $ 234,154 for bad debt provision, which was included in the General and Administrative expenses. Even though the bad debt provision recognized during the three months ended June 30, 2008 was $ 10,450, such number combined with the negative $234,154 number results in an increase of $244,604 in General and Administrative expenses. |
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development costs. For the three months ended June 30, 2008, research and development expense was $ 1,267,664, as compared to $ 330,797 for the same period of 2007, an increase of $ 936,867, as a result of the Company’s enhanced research and development activities on truck electronics.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense increased to $674,504 for the three months ended June 30, 2008, compared with that of $ 370,097 for the same period of 2007, an increase of $304,407. The increase in depreciation and amortization expense was primarily due to the purchase of plant and land use rights, and additional production equipment in the second half of 2007.
FINANCIAL EXPENSE
Financial expense mainly consists of interest expense and exchange loss. The financial expense for the three months ended June 30, 2008 increased by $269,052 to $383,320 from $ 114,268 for the same period of 2007, which was mainly attributed to a $106,725 increase in exchange loss resulted from the accelerated appreciation of Chinese currency against the U.S. dollar. Management is studying alternative methods for managing the risks associated with currency translation, such as the diversification of currencies used in export sales.
OTHER INCOME
Other income was $222,762 for the three months ended June 30, 2008, as compared to $ 351,932 for the three months ended June 30, 2007, a decrease of $129,170.The decrease was mainly due to a decrease in subsidy income from local governments for the three months ended June 30, 2008.
INCOME TAX
There was no income tax expense for the fiscal year ended December 31, 2005 and 2004. As a result of the Joint Venture obtaining its Sino-foreign joint venture status in 2004, in accordance with applicable PRC tax regulations, the Joint Venture was exempted from PRC income tax in both fiscal 2004 and 2005. Thereafter, the Joint Venture is entitled to a tax concession of 50% of the applicable income tax rate for the three years ended December 31, 2006, 2007, and 2008. With the new PRC Enterprise Income Tax Law, effective on 1st January 2008, the Company is generally subject to a PRC income tax rate of 12.5%. In accordance with China's relevant regulations of income taxes, the Joint Venture has a benefit of a refund of 40% of domestic equipment purchases from increased income taxes for the purchasing year over those of the previous year. During the second quarter ended June 30, 2007 and 2008, the Joint Venture received an income tax benefit of $991,133 and 384,342 for purchase of domestic equipment, respectively, which has been reflected as a reduction to current
income tax expense. As a result, income tax expense was $318,757 for the second quarter ended June 30, 2008 compared with negative $422,721 for the second quarter ended June 30, 2007, an increase of $ 741,478.
STOCK-BASED COMPENSATION
On March 1, 2006, the Board of Directors approved a total of 60,000 options to be issued to the four independent members of the Board of Directors. The contractual term of the options is three years. Total deferred stock-based compensation expenses related to stock options amounted to $178,904. This amount is amortized over the three-year vesting period in a manner consistent with Financial Accounting Standards Board Interpretation No. 123R. The amortization of deferred stock-based compensation for these equity arrangements was both $14,909 for the three months ended June 30, 2008 and 2007.
Although the Company anticipates future issuances of stock awards to have a material impact on reported net income, we do not expect these awards to have a material impact on future cash flow.
MINORITY INTEREST
Minority interest represents a 10% non-controlling interest in the Joint Venture. Minority interest in income amounted to $527,929 and $ 461,930 for the quarters ended June 30, 2008 and 2007, respectively.
FINANCIAL CONDITION
Liquidity and Capital Resources
OPERATING - Net cash provided in operating activities was $1,365,797 for the three months ended June 30, 2008 compared with $ 1,588,354 of net cash provided in operating activities in the same period in 2007, a decrease of $222,557.
During the three months ended June 30, 2008, our higher sales revenue resulted in increased accounts receivable. At the same time, in accordance with the increase in sales orders, the Company maintained a higher level of inventory to meet the requirements of sales and production. Additionally, China’s metal market experienced and is still experiencing price increases, which has resulted in an increase in our level of prepayments for metal raw materials. These factors resulted in an increased use of cash of approximately $2.8 million for the three months ended June 30, 2008 as compared to the same period of 2007. The increased use of cash was partly offset by the higher levels of deposits received from customers and accrued expense.
As of June 30, 2008, the Company had cash and cash equivalents of $ 4,481,177, as compared to cash and cash equivalents of $4,340,211 as of December 31, 2007. The Company had working capital of $57,232,993 as of June 30, 2008, as compared to working capital of 44,715,988 as of December 31, 2007, reflecting current ratios of 4.18:1 and 4.32:1, respectively.
INVESTING - During the three months ended June 30, 2008, the Company expended net cash of $630,146 in investing activities, including $552,037 for acquisition of property and equipment to support the growth of the business. For the three months ended June 30, 2007, the Company utilized $3,271,641 in investing activities.
FINANCING - In the second quarter of 2007, the cash inflows mainly attributable to a $1,492,396 increase in proceeds from borrowing due to one new loan being secured for new equipment purchases. During the second quarter ended June 30, 2008, the Company received new borrowing at $1,967,686 and repaid $1,037,327of its outstanding debt.
Management of the Company has taken a number of steps to restructure its customer base and phase out accounts which had failed to make prompt payments. The Company also placed more emphasis on receivable collection. In addition, the Company maintains good relationships with local banks. We believe that our current cash and cash equivalents and anticipated cash flow generated from operations and our bank lines of credit will be sufficient to finance our working capital requirements for the foreseeable future.
CURRENCY RISK AND FINANCIAL INSTRUMENTS - Although our reporting currency is the U.S. dollar, the functional currency of Joint Venture is RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our Renminbi revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. In recent years, the RMB has been appreciating against the U.S. dollar.
Assets and liabilities of our operating subsidiaries are translated into U.S. dollars at the exchange rate at the balance sheet date, their equity accounts are translated at historical exchange rate and their income and expenses items are translated using the average rate for the period. Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. Because of the approximately 2.3 % appreciation of the RMB against the USD during the quarter ended on June 30, 2008, (i) we recorded an exchange loss of $243,431 from export sales for which the payments to us were in USD, meanwhile, (ii) we also recorded a foreign currency translation adjustment of $1,899,674 for the quarter, a positive number due to our functional currency in RMB and the appreciation of the RMB against the USD. The Company is adopting such steps as the diversification of currencies used in export sales, and the negotiation of export contract with fixed exchange rate.
As the Company’s historical debt obligations are primarily short-term in nature, with fixed interest rates, the Company does not have any risk from an increase in market interest rates. However, to the extent that the Company arranges new borrowings in the future, an increase in market interest rate would cause a commensurate increase in the interest expense related to such borrowings.
(2) | Results of operations for the six months ended June 30, 2008 as compared to the six months ended June 30, 2007. |
SALES
Six Months ended | Six Months ended | ||||||||||||
30-Jun-08 | 30-Jun-07 | ||||||||||||
(U.S. dollars in millions) | |||||||||||||
Air brake valves & related components | $ | 55.7 | 77 | % | $ | 41.3 | 77 | % | |||||
Non-valve products | $ | 17.1 | 23 | % | $ | 12.3 | 23 | % | |||||
Total | $ | 72.8 | 100 | % | $ | 53.6 | 100 | % |
Sales consist of air brake valves and related components manufactured by SORL and sold to domestic original equipment manufacturers (OEM), aftermarket customers and export market as well as distribution of non-valve auto parts sourced from the Ruili Group.
Net sales were $ 72,844,561 and $ 53,606,561 for the six months ended June 30, 2008 and 2007, respectively. Compared with the same period of 2007, Net sales for the six months ended June 30, 2008 increased by $19.2 million or 35.9% to $72.8 million. The increase in sales was a result of the increased demand for commercial vehicle parts in China and continued expansion of our export sales.
A breakdown of net sales revenue for these markets for the six months ended on June 30, 2008 and 2007, respectively, is set forth below:
Six Months | Six Months | ||||||||||||
ended | ended | ||||||||||||
30-Jun-08 | % | 30-Jun-07 | % | ||||||||||
(U.S. dollars in million) | |||||||||||||
China OEM market | $ | 28.2 | 39 | % | $ | 20.9 | 39 | % | |||||
China Aftermarket | $ | 20.4 | 28 | % | $ | 13.4 | 25 | % | |||||
International market | $ | 24.2 | 33 | % | $ | 19.3 | 36 | % | |||||
Total | $ | 72.8 | 100 | % | $ | 53.6 | 100 | % |
Although during the first two months of 2008, transportation in China was heavily affected by significant snow storms in central and east China, our Chinese OEM sales achieved an approximately 34.9% year-over-year growth, increasing from $20.9 million in the first half year of 2007 to $28.2 million. With the approaching of implementation of the China III emission standard beginning July 1, 2008, the consumption of trucks equipped with China II engines was significantly spurred before the policy was enforced, which in turn boosted the output and sales volume of vehicles made in China.
However, we take a conservative view on whether the increased consumption of trucks will continue in the next two quarters. We think that the additional costs required to achieve China III compliance will lead to higher vehicle prices, which will likely to discourage demand for various vehicles. Further, during 2008 Beijing Olympic Games period, our major customers, such as FAW Qiongdao, Beiqi Foton Zhucheng and Beiqi Foton Aumen will halt production due to the traffic control in the regions around Beijing. Consequently, our near-term OEM sales in the second half year might be cutback.
Due to on our well established sales networks and our increased production capacity, the Company achieved total revenue of $20.4 million in Chinese aftermarket sales for the six months ended June 30, 2008, an increase of $7.0 million, or 52.2% as compared to the same period of last year.
Our export sales grew by $4.9 million or approximately 25.4% for the six months ended June 30, 2008, as compared to $19.3 million for the same period of 2007. This increase reflects the introduction of new products, the improvement in technological support, the expansion of the contract sales force and the implementation of a market plan focusing on the export market segment.
COST OF SALES
Cost of sales for the six months ended June 30, 2008 increased to $52,793,354 from $ 41,555,339 for the same period of 2007, a $11,238,015 or 27.0% increase, compared with total sales growth of 35.9% for the period.
GROSS PROFIT
From $ 12,051,222 for the six months of 2007 to $ 20,051,207 for the six months of 2008, our gross profit grew by 66.4%, exceeding our revenue growth rate. Therefore, gross margin increased 5.0% for the six months ended June 30, 2008, to 27.5% from 22.5 % for the same period of 2007.
The higher gross margin was the result of raising prices and cutting production costs. The Joint Venture continued to improve production methods in its manufacturing process. This has resulted in reducing the manufacturing cycle, reducing waste, and thereby reducing production cost. Also, favorable changes in product and market mix helped raise the average selling price of our products. For the Chinese OEM market, we have sold more system products as opposed to individual components. For the Chinese and the international aftermarkets, we have been able to pass part of our cost increases to the end users, largely due to an uptrend in the prices for truck parts from China. The successful expansion of our sales into the higher margin municipal bus market has also contributed to the gross margin improvement of the Joint Venture since the last quarter of 2007.
SELLING AND DISTRIBUTION EXPENSES
Selling and distribution expenses were $ 4,611,078 for the six months ended June 30, 2008, as compared to $ 2,515,290 for the same period of 2007, an increase of $ 2,095,788 or 83.3%.
Selling and distribution expenses include salaries and wages, transportation expense, packaging expense, warranty expense, expenses associated with traveling, advertising, promotions, trade shows and seminars, and other expenses. Selling and distribution expenses for the six months ended June 30, 2008 increased primarily due to these factors:
(1) | Increased transportation expense: During the six months of 2008, transportation costs increased by $865,519 as compared to $584,397 for the same period of 2007. The increase in transportation expense was mainly due to increased sales and the rise in the transportation cost resulted from the increased price of oil and the increased number of loads necessitated by the overloading control measures imposed by the Chinese government since the third quarter of 2007. |
(2) | Increased packaging expense: Packaging costs were $1,311,023 for the six months ended June 30, 2008, an increase of $ 409,458 as compared with the same period of 2007, which was consistent with the revenue growth. |
(3) | Increased product warranty expense. The Company recorded $1,060,353 of product warranty expenses for the six months ended June 30, 2008, as compared to $ 585,888 for the six months ended June 30, 2007, an increase of $474,465. |
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $ 4,694,418 for the six months ended June 30, 2008, as compared to $2,720,623 for the same period of 2007, an increase of $ 1,973,795 or 72.6% mainly due to the following factors:
(1) | The expansion of economic activities, facilities and workforce resulted in increased depreciation, office expenses, staff salary, work insurance and welfare, travel expenses and other miscellaneous fees totaling $2,506,665, an increase of $739,624 as compared to the same period of 2007. |
(2) | R&D expense, which is included in general and administrative expenses, increased by $1,096,616, as compared to $ 553,672 of R&D expense for the same period of 2007, as discussed below. |
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development costs. For the six months ended June 30, 2008, research and development expense was $1,736,962, as compared to $ 553,672 for the same period of 2007, an increase of $1,183,290, as a result of the Company’s enhanced research and development activities on truck electronics.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense increased to $1,329,059 for the six months ended June 30, 2008, compared with that of $710,394 for the same period of 2007, an increase of $618,665. The increase in depreciation and amortization expense was primarily due to the purchase of plant and land use rights, and additional production equipment in the second half of 2007.
FINANCIAL EXPENSE
Financial expense mainly consists of interest expense and exchange loss. The financial expense for the six months ended June 30, 2008 increased by $495,560 to $752,996 from $ 257,436 for the same period of 2007, which was mainly attributed to a $302,884 increase in exchange loss resulted from the accelerated appreciation of Chinese currency against the U.S. dollar. Management is studying alternative methods for managing the risks associated with currency translation, such as the diversification of currencies used in export sales.
OTHER INCOME
Other income was $333,840 for the six months ended June 30, 2008, as compared to $ 384,272 for the six months ended June 30, 2007, a decrease of $50,432. The decrease was mainly due to a decrease in subsidy income from local governments for the six months ended June 30, 2008.
INCOME TAX
There was no income tax expense for the fiscal year ended December 31, 2005 and 2004. As a result of the Joint Venture obtaining its Sino-foreign joint venture status in 2004, in accordance with applicable PRC tax regulations, the Joint Venture was exempted from PRC income tax in both fiscal 2004 and 2005. Thereafter, the Joint Venture is entitled to a tax concession of 50% of the applicable income tax rate for the three years ended December 31, 2006, 2007, and 2008. With the new PRC Enterprise Income Tax Law, effective on 1st January 2008, the Company is generally subject to a PRC income tax rate of 12.5%. In accordance with China's relevant regulations of income taxes, the Joint Venture has a benefit of a refund of 40% of domestic equipment purchases from increased income taxes for the purchasing year over those of the previous year. During the second quarter ended June 30, 2007 and 2008, the Joint Venture received an income tax benefit of $991,133 and 384,342 for purchase of domestic equipment, respectively, which has been reflected as a reduction to current income tax expense. As a result, income tax expense was $882,231for the six months ended June 30, 2008 compared with negative $60,256 for the six months ended June 30, 2007, an increase of $942,487.
STOCK-BASED COMPENSATION
On March 1, 2006, the Board of Directors approved a total of 60,000 options to be issued to the four independent members of the Board of Directors. The contractual term of the options is three years. Total deferred stock-based compensation expenses related to stock options amounted to $178,904. This amount is amortized over the three-year vesting period in a manner consistent with Financial Accounting Standards Board Interpretation No. 123R. The amortization of deferred stock-based compensation for these equity arrangements was both $ 29,818 for the six months ended June 30, 2008 and 2007.
Although the Company anticipates future issuances of stock awards to have a material impact on reported net income, we do not expect these awards to have a material impact on future cash flow.
MINORITY INTEREST
Minority interest represents a 10% non-controlling interest in the Joint Venture. Minority interest in income amounted to $921,948 and $ 697,119 for the six months ended June 30, 2008 and 2007, respectively.
FINANCIAL CONDITION
Liquidity and Capital Resources
OPERATING - Net cash provided in operating activities was $ 2,609,173 for the six months ended June 30, 2008 compared with $ 1,694,076 of net cash used in operating activities in the same period in 2007, an increase of $4,303,249. During the six months ended June 30, 2008, our higher sales revenue resulted in increased accounts receivable. At the same time, in accordance with the increase in sales orders, the Company maintained a higher level of inventory to meet the requirements of sales and production. Additionally, China’s metal market experienced and is still experiencing price increases, which has resulted in an increase in our level of prepayments for metal raw materials. These factors resulted in an increased use of cash of approximately $5.7 million for the six months ended June 30, 2008 as compared to the same period of 2007. The increased use of cash was offset by the higher levels of deposits received from customers, accrued expense, accounts payable and notes payable and other current assets and liability.
As of June 30, 2008, the Company had cash and cash equivalents of $ 4,481,177, as compared to cash and cash equivalents of $4,340,211as of December 31, 2007. The Company had working capital of $57,232,993 as of June 30, 2008, as compared to working capital of 44,715,988 as of December 31, 2007, reflecting current ratios of 4.18:1 and 4.32:1, respectively.
INVESTING - During the six months ended June 30, 2008, the Company expended net cash of $1,188,165 in investing activities, including $1,109,428 for acquisition of property and equipment to support the growth of the business. For the six months ended June 30, 2007, the Company utilized $ 5,355,276 in investing activities.
FINANCING - Net cash used by financing activities was $1,502,107 for the six months ended June 30, 2008 compared to $1,492,396 used in financing activities in the same period in 2007. During the six months ended June 30, 2007, the cash inflows were mainly attributable to a $1,492,396 increase in proceeds from borrowing due to one new loan being secured for new equipment purchases. During the six months ended June 30, 2008, the Joint Venture received aggregate bank loans in the amount of $1,967,686 under its credit facilities; the impact of these cash inflows was offset by repayments of $3,469,793 on its outstanding debt.
Management of the Company has taken a number of steps to restructure its customer base and phase out accounts which had failed to make prompt payments. The Company also placed more emphasis on receivable collection. In addition, the Company maintains good relationships with local banks. We believe that our current cash and cash equivalents and anticipated cash flow generated from operations and our bank lines of credit will be sufficient to finance our working capital requirements for the foreseeable future.
CURRENCY RISK AND FINANCIAL INSTRUMENTS - Although our reporting currency is the U.S. dollar, the functional currency of Joint Venture is RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our Renminbi revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. In recent years, the RMB has been appreciating against the U.S. dollar.
Assets and liabilities of our operating subsidiaries are translated into U.S. dollars at the exchange rate at the balance sheet date, their equity accounts are translated at historical exchange rate and their income and expenses items are translated using the average rate for the period. Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. Because of the approximately 6.1 % appreciation of the RMB against the USD during the six months ended on June 30, 2008, (i) we recorded an exchange loss of $583,978 from export sales for which the payments to us were in USD, meanwhile, (ii) we also recorded a foreign currency translation adjustment of $4,923,575 for the six-month period, a positive number due to our functional currency in RMB and the appreciation of the RMB against the USD. The Company is adopting such steps as the diversification of currencies used in export sales, and the negotiation of export contract with fixed exchange rate.
As the Company’s historical debt obligations are primarily short-term in nature, with fixed interest rates, the Company does not have any risk from an increase in market interest rates. However, to the extent that the Company arranges new borrowings in the future, an increase in market interest rate would cause a commensurate increase in the interest expense related to such borrowings.
OFF-BALANCE SHEET AGREEMENTS
As of June 30, 2008, 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.
The information is not required for smaller reporting companies.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) and Rule 15d-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management, including our Chief Executive Officer and Chief Financial Officer, evaluated, as of June 30, 2008, the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) and Rule 15d-15(e). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of June 30, 2008, were effective for the purpose of ensuring that information required to be disclosed by us in this report is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
We believe, however, that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, within a company have been detected.
Changes in Internal Control over Financial Reporting
There was no change in our internal controls over financial reporting during the fiscal quarter ended June 30, 2008 covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
EXHIBIT NO. | DOCUMENT DESCRIPTION |
3.1 (1) | Articles of Incorporation |
3.2 (1) | Bylaws |
4.1 (2) | Form of Underwriters’ Common Stock Purchase Warrants |
4.2 (2) | Specimen Common Stock Certificate |
31.1 (3) | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended. |
31.2 (3) | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended. |
32.1 (4) | Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Chief Financial Officer). |
(1) | Incorporated herein by reference from the Registrant’s Form 10-QSB filed with the Securities and Exchange Commission on May 28, 2003. |
(2) | Incorporated herein by reference from the Registrant’s Registration Statement on Form S-1, Commission File No. 333-137019, as filed with the Securities and Exchange Commission on August 31, 2006. |
(3) | Filed herewith. |
(4) | Furnished herewith. 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. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated : August 13, 2008 | SORL AUTO PARTS, INC. | |
By: /s/ Xiao Ping Zhang | ||
Name: Xiao Ping Zhang | ||
Title: Chief Executive Officer |
By: /s/ Zong Yun Zhou | ||
Name: Zong Yun Zhou | ||
Title: Chief Financial Officer | ||
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