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SORL > SEC Filings for SORL > Form 10-Q on 14-Nov-2012All Recent SEC Filings

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Form 10-Q for SORL AUTO PARTS INC


14-Nov-2012

Quarterly Report


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

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

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

OVERVIEW

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

Results of Operations

On November 5, 2012, SORL announced the Company received a 400-unit order for its new electric air compressor from Shen Zhen Wuzhoulong Motors Group. Released in July 2012, the new electric air compressor is selling at 8,000 RMB per unit. In addition to Wuzhoulong, the Company has also received indication of purchasing interest for the same products from other large bus manufacturers in China.

On October 15, 2012, SORL announced that the Company obtained a patent in the People's Republic of China ("PRC") for a new proprietary electric air dryer that is specifically designed for new energy electric buses and specialty commercial vehicles. Equipped with an internal electronic control unit to achieve continuing desiccant regeneration, SORL's new electric air dryer has a prolonged useful life and improves the working environment of the vehicle's air control system. As a result, the dryer extends the operating life of the entire air control system and improves the vehicles' safety performance. The patent will be in effect from 2012 through 2030.

On September 24, 2012, the Company announced that it won a new contract from Shanxi Automobile Group Co., Ltd. ("Shanqi") to supply 90% of the re-card spring brake chambers for the Delong F3000 heavy-duty truck models. The Delong F3000 series is one of the heavy-duty truck models from Shaanxi Auto and it possesses the versatility to be used in logistics, heavy loads, construction and bridge building, ore transportation, municipal sanitation and the transportation of dangerous goods. The new F3000 provides superior quality for its customers.

On August 27, 2012, SORL announced the launch of its newly developed electrically controlled power steering pump, marking a technological breakthrough for the electric bus market. SORL's electrically controlled power steering pump is specifically designed for use in new energy electric buses.

On July 18, 2012, Company announced it had launched a new generation of electric air brake compressors to be used in electric buses. Air brake compressors used in traditional vehicles are powered by an internal combustion engine. SORL's new generation of electric air brake compressors are powered by an electric motor, thereby increasing fuel conservation and reducing pollution. The new compressors have an extended life span as it is far easier to make them start or stop working. An electric air compressor is a necessity for all electric buses with an air brake system.

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

SALES



                                           Three Months ended          Three Months ended
                                           September 30, 2012          September 30, 2011
                                                          (U.S.  dollars in
                                                              millions)
Commercial vehicle brake systems, etc.   $    36.3          77.7 %   $    35.9          75.4 %
Passenger vehicle brake systems, etc.    $    10.4          22.3 %   $    11.7          24.6 %

Total                                    $    46.7         100.0 %   $    47.6         100.0 %

Net sales were $46,708,959 and $47,583,678 for the three months ended September 30, 2012 and 2011, respectively, a decrease of $0.9 million or 1.9%.

The sales from commercial vehicle brake systems increased by $0.4 million or 1.1%, to $36.3 million for the third quarter of 2012, compared to $35.9 million for the same period of 2011.

The sales from passenger vehicle brake systems decreased by $1.3 million or 11.1%, to $10.4 million for the third quarter of 2012, compared to $11.7 million for the same period of 2011.

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

                                         Three                              Three
                                         Months                            Months
                                         ended           Percent            ended            Percent
                                       September           of            September             of            Percentage
                                        30, 2012       Total Sales        30, 2011         Total Sales         Change
                                                          (U.S. dollars in millions)
China OEM market                       $     18.7              40.0 %   $        20.8              43.8 %          -10.1 %
China Aftermarket                      $     12.2              26.1 %   $        11.6              24.3 %            5.2 %
International market                   $     15.8              33.8 %   $        15.2              32.0 %            3.9 %
Total                                  $     46.7             100.0 %   $        47.6             100.0 %           -1.9 %

Chinese domestic macro-economic environment, including consumer confidence and industrial activities, as well as relevant policies and regulations resulted in a low-growth environment for the automotive industry in the nine months of 2012, caused the growth rate in vehicle sales decline from the comparable period of 2011. For the first time in China's industrialization and urbanization era, the growth rate of automotive vehicle sales declined over the nine month periods in two consecutive years, 2011 and 2012. However, this low-growth development is also partially a result of the significant and possibly one-time only increases in vehicle sales experienced in 2009 and 2010, and the PRC government is guiding the automotive industry to develop at a more rational long-term growth rate. To prevent sales to the OEM market from deteriorating, the Company enhanced its product line with a broader range of products through innovative new products as well as penetrating new market segments, such as the bus and the light-duty vehicle markets. As a result, our sales to the Chinese OEM market decreased by $2.1 million or 10.1%, to $18.7 million for the third quarter of 2012, compared to $20.8 million for the three month period ended September 30 of 2011.

Our sales to the Chinese aftermarket increased by $0.6 million or 5.2%, to $12.2 million for the third quarter of 2012, compared to $11.6 million for the same period of 2011, due to overall slowdown in the auto parts market in China. The increased number of new vehicle sales in China and the expiration of OEM warranties helped drive our aftermarket business. Sales of our new model products, applicable to both OEM and aftermarket, also grew during the three months ended September 30, 2012. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets. Accelerated urbanization and the Chinese government's increased support for public transportation favor expansion in the bus aftermarket.

Our export sales increased by $0.6 million or 3.9%, to $15.8 million for the third quarter of 2012, as compared to $15.2 million for the same period of 2011. It was mainly due to the improving conditions in the U.S. market and a broadening customer base, as well as the Company's continuous strategy to strengthen and extend its distribution networks to focus on increasing recognition of SORL's products by end users.

We will take the following measures to ensure future growth in the international market:

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

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

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

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

COST OF SALES AND GROSS PROFIT

Cost of sales for the three months ended September 30, 2012 were $33,485,059, a decrease of $1,046,145 or 3.0%, from $34,531,204 for the three month period ended September 30, 2011. Our gross profit increased by 1.3% from $13,052,474 for the same period in 2011 to $13,223,900 for the three month period ended September 30, 2012.

Gross margin increased to 28.3% from 27.4% for the three month period ended September 30, 2012 compared with 2011, primarily resulted from the increase of gross margin of our passenger vehicle business, but partly offset by the decrease in the gross margin of our commercial vehicle business. Gross margin is being affected by labor expenses, the fluctuation of the Chinese currency, and raw material costs, as well as our product mix in each of our commercial vehicle and passenger vehicle businesses.

Cost of sales from commercial vehicle brake systems for the three months period ended September 30, 2012 were $26.5 million, an increase of $0.5 million or 2.2% from $ 26.0 million for the same period last year. Such increase was primarily resulted from the increase of sales from commercial vehicle brake systems by $0.4 million or 1.1%. Since the increase of our cost of sales in the commercial vehicle business outpaced our increase in the sales from commercial vehicle business, the gross profit from commercial vehicle brake systems decreased by 1.7% from $9.9 million for three month period ended September 30, 2011, to $9.7 million for the three month period ended September 30, 2012. Gross margin from commercial vehicle brake systems decreased to 26.9% from 27.6% for the three months period ended September 30, 2012, compared to the three month period ended September 30, 2011. The decrease was mainly due to rising labor expenses, the appreciation of the Chinese currency, and higher raw material prices.

Cost of sales from passenger vehicle brake systems for the three months period ended September 30, 2012 were $7.0 million, a decrease of $1.6 million or 18.9%, from $8.6 million for the three month period ended September 30, 2011. Such decrease primarily resulted from the decrease of sales by $1.3 million, or 11.1% in our passenger vehicle business. The gross profit from passenger vehicle brake systems increased by 10.9% from $3.1 million for the three month period ended September 30, 2011, to $3.5 million for the three month period ended September 30, 2012.

Gross margin from passenger vehicle brake systems increased to 33.4% from 26.8% for the three months ended September 30, 2012, as compared with 2011. The increase of our gross margin primarily resulted from the increase of our production efficiency and the increase of the weight of higher value-added, more technologically advanced products in our product portfolio in our passenger vehicle business, and partly offset by the increase in labor expenses, the appreciation of the Chinese currency, and higher raw material costs.

SELLING AND DISTRIBUTION EXPENSES

Selling and distribution expenses were $3,765,768 for the three months ended September 30, 2012, as compared to $2,923,832 for the same period of 2011, an increase of $841,936 or 28.8%. The increase was mainly due to increased packaging expense and selling- and distribution- related travel expenses.

Selling and distribution expenses as a percentage of sales revenue increased to 8.1% for the three months ended September 30, 2012, as compared to 6.1% for the same period in 2011, primarily due to the increase of total amount of selling and distribution expenses and the decrease of sales by $0.9 million from $47.6 million from the three months ended September 30, 2011 to $46.7 million from the three months ended September 30, 2012.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses were $2,630,786 for the three months ended September 30, 2012, as compared to $2,968,222 for the same period of 2011, a decrease of $337,436 or 11.4%. The general and administrative expenses decreased as a result of certain adjustments for the prior period and decreased sales for the current period. The Company incurred fewer expenses in relation to reduced sales .Since the decrease of our general and administrative expenses outpaced the decrease of our sales, general and administrative expenses, as a percentage of sales revenue, decreased from 6.2% for the same period in 2011 to 5.6% for the three months ended September 30, 2012.

RESEARCH AND DEVELOPMENT EXPENSE

Research and development expenses include payroll, employee benefits, and other personnel-related expenses associated with product development. Research and development expenses also include third-party development costs. For the three months ended September 30, 2012, research and development expense was $2,352,958, as compared to $1,893,985 for the same period of 2011, an increase of $458,973.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization expense decreased by $7,161 to $1,814,794 for the three months ended September 30, 2012, compared with that of $1,821,955 for the same period of 2011. The de minis decrease in depreciation and amortization expense primarily resulted from a stable portfolio of production equipment and facilities.

FINANCIAL EXPENSE

Financial expense mainly consists of interest expense, the financing expense associated with our capital lease transaction and exchange loss. The financial expense for the three months ended September 30, 2012, decreased by $686,176 to $541,326 from $1,227,502 for the same period of 2011, which was mainly due to lower interest rates.

OTHER INCOME

Other income was $1,207,961 for the three months ended September 30, 2012, as compared to $488,747 for the three months ended September 30, 2011, an increase of $719,214. The increase was mainly due to an increase in sales of raw material scrap for the three months ended September 30, 2012.

INCOME TAX

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

The Company increased its investment in the Joint Venture as a result of its financing in December, 2006. In accordance with the Income Tax Law of the People's Republic of China on Foreign-invested Enterprises and Foreign Enterprises, the Joint Venture was eligible for additional preferential tax treatment for the years 2007 and 2008. In those years, the Joint Venture was entitled to an income tax exemption on all pre-tax income generated by the Company above its pre-tax income generated in the fiscal year 2006. This tax exemption was superseded as a result of the Joint Venture having been awarded the Chinese government's "High-Tech Enterprise" designation. The High-Tech Enterprise certificate was valid for three years and provided for a reduced tax rate for years 2009 through 2011. Thus, our effective income tax rate was 15% for years 2009 through 2011. For the quarter ended September 30, 2012, the effective income tax rate was 25%. However, the Company is in the process of renewing its "High-Tech Enterprise" certificate. If this renewal is successful, the effective income tax rate may be reduced to 15% later in 2012.

Income tax expense of $1,180,601 and $660,446 was recorded for the quarters ended September 30, 2012 and 2011, respectively. The increase was due to the increase of the income before provision for income taxes from $4.5 million for the three months ended September 30, 2011 to $5.0 million for the three months ended September 30, 2012, and the increase of our effective tax from 15% to 25% for the same period.

STOCK-BASED COMPENSATION

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

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

NET INCOME ATTRIBUTABLE TO NON-CONTROLLING INTEREST IN SUBSIDIARIES

Non-controlling interest in subsidiaries represents a 10% non-controlling interest in Ruian and 40% non-controlling interest in SIH, in each case held by our Joint Venture partners. Net income attributable to non-controlling interest in subsidiaries amounted to $486,581 and $358,632 for the third quarter ended September 30, 2012 and 2011, respectively.

NET INCOME ATTRIBUTABLE TO STOCKHOLDERS

The net income attributable to stockholders for the quarter ended September 30, 2012, decreased by $145,892, to $3,360,914 from $3,506,806 for the quarter ended September 30, 2011 due to the factors discussed above. Earnings per share ("EPS"), both basic and diluted, for the quarter ended September 30, 2012 and 2011, were $0.17 and $0.18 per share, respectively.

Results of operations for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011.

SALES



                                             Nine months ended           Nine months ended
                                            September 30, 2012          September 30, 2011
                                                           (U.S.  dollars in
                                                               millions)
Commercial vehicles brake systems, etc.   $     111.7        77.9 %   $     125.1        77.9 %
Passenger vehicles brake systems, etc.    $      31.7        22.1 %   $      35.6        22.2 %

Total                                     $     143.4       100.0 %   $     160.7       100.0 %

Net sales were $143,399,372 and $160,683,535 for the nine months ended September 30, 2012 and 2011, respectively, a decrease of $17.3 million or 10.8%.

The sales from commercial vehicle brake systems decreased by $13.4 million or 10.7%, to $111.7 million for the nine months ended September 30, 2012, compared to $125.1 million for the same period of 2011. Due to the slowdown of the commercial vehicle market in the nine months ended September 30, 2012, the sales from the OEM market decreased, which impacted the sales of the commercial vehicle brake systems.

The sales from passenger vehicle brake systems decreased by $3.9 million or 11.0%, to $31.7 million for the nine months ended September 30, 2012, compared to $35.6 million for the same period of 2011.

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

                          Nine                         Nine
                         months        Percent        months        Percent
                          ended           of           ended           of
                        September       Total        September       Total       Percentage
                        30, 2012        Sales        30, 2011        Sales       Change
                                             (U.S. dollars in millions)
China OEM market       $      70.1         53.2 %   $      85.5           53 %          -18.0 %
China Aftermarket      $      33.7         22.2 %   $      32.9           21 %            2.4 %
International market   $      39.6         24.6 %   $      42.3           26 %           -6.4 %
Total                  $     143.4        100.0 %   $     160.7        100.0 %          -10.8 %

Chinese domestic macro-economic environment, including consumer confidence and industrial activities, as well as relevant policies and regulations have resulted in a low-growth environment for the automotive industry in the nine months of 2012, caused the growth rate in vehicle sales again declined from the low base in the comparable period of 2011. For the first time in China's industrialization and urbanization era, the growth rate of automotive vehicle sales has declined over the nine month periods in two consecutive years, 2011 and 2012. However, this low-growth development is also partially a result of the significant and possibly one-time only increases in vehicle sales experienced in the 2009 and 2010 years, and the PRC government is guiding the automotive industry to develop at a more rational long-term growth rate. To prevent sales to the OEM market from deteriorating further, the Company has maintained its market position in the Chinese OEM market by enhancing its product line with a broader range of products through innovative new products as well as penetrating new market segments such as the bus and the light-duty vehicle markets. As a result, our sales to the Chinese OEM market decreased by $15.4 million or 18.0%, to $51.4 million for the nine months ended September 30, 2012, compared to $85.5 million for the same period of 2011.

Our sales to the Chinese aftermarket increased by $0.8 million or 2.4%, to $33.7 million for the nine months ended September 30, 2012, compared to $32.9 million for the same period of 2011. The increased number of new vehicle sales in China and the expiration of OEM warranties helped drive the increase in our aftermarket business. Sales of our new model products, applicable to both OEM and aftermarket, also grew during the nine months ended September 30, 2012. We will continue with our strategies to further optimize our sales network and to help further penetrate into new markets. Accelerated urbanization and the Chinese government's increased support for public transportation favor expansion in the bus aftermarket.

Our export sales decreased by $2.7 million or 6.4%, to $39.6 million for the nine months of 2012, as compared to $42.3 million for the same period of 2011. The debt crisis in Europe and the currency depreciation in some countries caused some of our customers to reduce their inventories. Moreover, the instability of the political situation in the Middle Eastern countries restricted the purchases of our customers from us. We will take the following measures to ensure future growth in the international market:

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

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

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

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

COST OF SALES AND GROSS PROFIT

Cost of sales for the nine months ended September 30, 2012 were $103,779,982, a decrease of $12,679,680 or 10.9% from $116,459,662 for the same period last year. Our gross profit decreased by 10.4% from $44,223,873 for the nine months ended September 30, 2011 to $39,619,390 for the same period of 2012. Both the decrease of cost of sales and gross profit primarily resulted from the decrease of sales from $161 million from the nine months ended September 30, 2011 to $143 million for the nine months ended September 30, 2012.

Gross margin increased to 27.6% from 27.5% for the nine months ended September 30, 2012, as compared with the same period of 2011, primarily resulted from the increase of gross margin of our passenger vehicle business, but offset by the decrease in the gross margin of our commercial vehicle business. Gross margin is being affected by labor expenses, the fluctuation of the Chinese currency, and raw material costs, as well as our product mix in each of our commercial vehicle and passenger vehicle businesses.

Cost of sales from commercial vehicle brake systems for the nine months ended September 30, 2012 were $80.9 million, a decrease of $9.6 million or 10.6% from $90.4 million for the same period of 2011. The gross profit from commercial vehicle brake systems decreased by 11.2% from $34.7 million for the nine months ended September 30, 2011 to $30.8 million for the same period of 2012. Both the decrease of cost of sales and the decrease of gross profit primarily resulted from the decrease of sales from $125.1 million from the nine months ended September 30, 2011 to $111.7 million for the nine months ended September 30, 2012 for our commercial vehicle business.

Gross margin from commercial vehicle brake systems decreased to 27.6% from 27.7% for the nine months ended September 30, 2012 compared with the same period of 2011. The decrease in the gross margin was mainly due to rising labor expenses, the appreciation of the Chinese currency, and higher raw material costs.

Cost of sales from passenger vehicle brake systems for the nine months ended September 30, 2012 were $22.9 million, a decrease of $3.1 million or 11.9% from $26.0 million for the same period of 2011. The gross profit from passenger vehicle brake systems decreased by 7.5% from $9.5 million for the nine months ended September 30, 2011 to $8.8 million for the same period of 2012. Both the decrease of cost of sales and the decrease of gross profit from our passenger vehicle business primarily resulted from the decrease of our sales from passenger vehicle business from $35.6 million for the nine months ended September 30, 2011 to $31.7 million for the nine months ended September 30, 2012.

Gross margin from passenger vehicle brake systems increased to 27.8% from 26.8% for the nine months ended September 30, 2012, as compared with the same period in 2011. The increase of our gross margin primarily resulted from the increase . . .

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