ITEM 1. DESCRIPTION OF BUSINESS
BUSINESS
Through its 90% ownership of the Ruili
Group Ruian Auto Parts Co., Ltd., a Sino-Foreign joint venture (the “Joint Venture” or “Ruian”), SORL Auto Parts, Inc.
(together with its subsidiaries, “we,” “us,” “our” or the “Company” or
“SORL”) develops, manufactures and distributes automotive brake systems and other key safety related auto parts
to automotive original equipment manufacturers, or OEMs, and the related aftermarket both in China and aboard. The
Company’s products are used in different types of commercial vehicles, such as trucks and buses. Automotive brake
systems and other key safety related auto parts are critical components that ensure driving safety.
The Joint Venture was formed in the People’s
Republic of China (“PRC” or “China”) as a Sino-Foreign joint venture on January 17, 2004, pursuant to the
terms of a Joint Venture Agreement (the “JV Agreement”) between the Ruili Group Co., Ltd. (the “Ruili Group”)
and Fairford Holdings Limited (“Fairford”), a wholly owned subsidiary of the Company. The Ruili Group was incorporated
in China in 1987 and specialized in the development, production and sale of various kinds of automotive parts. Fairford and the
Ruili Group contributed 90% and 10%, respectively, of the paid-in capital of the Joint Venture, which totaled $7.1 million.
On January 19, 2004 the Joint Venture acquired
the business segment of the Ruili Group relating to manufacture and sale of various kinds of valves for automotive brake systems
and related operations (the “Transferred Business”). The Ruili Group began the automotive air brake valve business
in 1987. The acquisition was accomplished by transfer from the Ruili Group to Fairford of relevant assets and liabilities of the
Transferred Business including trade receivables, inventories and machineries, and the assumption of short and long term borrowings
for a purchase price of $6,390,000. The consideration was based on a valuation provided by Ruian Ruiyang Assets Valuation Co.,
Ltd., an independent PRC valuation firm. Fairford then transferred these assets and liabilities to the Joint Venture as consideration
for its 90% ownership interest of the Joint Venture. The Ruili Group transferred inventory as its capital contribution for its
10% interest in the Joint Venture. The assets and liabilities transferred to the Joint Venture by Fairford and the Ruili Group
represented all the assets and liabilities of the Transferred Business. Certain historical information of the Transferred Business
is based on the operation of the Transferred Business when it was owned by the Ruili Group.
On November 30, 2006, the Company completed
a follow-on public offering of 4,285,714 shares of common stock at $7.25 per share. Gross proceeds were approximately $31.1 million.
Net proceeds after approximately $2.2 million of underwriters’ commissions and approximately $0.7 million of related offering
expenses were approximately $28.2 million. On December 13, 2006, Maxim Group LLC, the lead underwriter of offering, exercised its
over-allotment option in full to purchase an additional 642,857 shares of common stock. After deduction of underwriter’s
discount of approximately $0.3 million, the Company received approximately $4.3 million. The aggregate net proceeds to the Company
of this offering were approximately $32.5 million, which included the approximate $4.3 million as a result of the exercise of the
over-allotment option granted to the underwriters.
On December 8 and 26, 2006, pursuant to
the terms of the Joint Venture Agreement (revised), through Fairford, the Company invested $32.67 million in its operating subsidiary,
the Joint Venture. To maintain its 10% shareholding in the Joint Venture, the Ruili Group increased its capital investment by $3.63
million. Accordingly, the Company continued to hold a 90% controlling interest in the operating subsidiary. Pursuant to the JV
Agreement and the Joint Venture Agreement (revised), the total paid-in capital of the Joint Venture increased from $7.1 million
to $43.4 million.
On November 11, 2009, the
Company entered into a joint venture agreement with MGR Hong Kong Limited (“MGR”), a Hong Kong-based global auto parts distribution
specialty firm and a Taiwanese investor. The new joint venture was named SORL International Holding, Ltd. ("SIH").
SORL holds a 60% interest in SIH, MGR holds a 30% interest, and the Taiwanese investor holds a 10% interest. SIH is primarily
devoted to expanding SORL's international sales network in the Asia-Pacific region and creating a larger footprint in Europe,
the Middle East and Africa with a target to create a truly global distribution network. Based in Hong Kong, SIH is expanding
and establishing channels of distribution in international markets.
On February 8, 2010, the Company sold 1,000,000
shares of its common stock to selected institutional investors at a price of $10.00 per share pursuant to a registered direct offering.
This transaction provided net proceeds of approximately $9.4 million. On March 9, 2010, through Fairford, SORL invested approximately
$9.4 million in its operating subsidiary, the Joint Venture. To maintain its 10% shareholding in the Joint Venture, the Ruili Group
increased its capital investment by approximately $1.0 million. Accordingly, SORL continues to hold a 90% controlling interest
in the operating subsidiary. The total paid-in capital of the Joint Venture increased from $43.4 million to $53.8 million.
On August 31, 2010, the Company, through
the Joint Venture, executed an Agreement to acquire the assets of the hydraulic brake, power steering, and automotive electrical
operations of the Ruili Group, a related party under common control. As a result of this acquisition, the Company's product offerings
expanded to both commercial and passenger vehicles' brake systems and other key safety-related auto parts. The purchase price was
RMB170 million, or approximately USD$25 million. The transaction was accounted for using the book basis of assets acquired, consisting
primarily of machinery and equipment, inventory, accounts receivable and patent rights, used or usable in connection with the acquired
segment of the auto parts business of the Ruili Group. The Company purchased the machinery and equipment, inventory, accounts receivable
at book values of $8.0 million, $8.0 million and $5.2 million, respectively. The Company did not acquire any of the assets of the
Ruili Group other than as described above. The excess of consideration over the carrying value of net assets received has been
recorded as a decrease in the additional paid-in capital of the Company.
The acquisition was accounted for as a transaction
between the entities under common control because the CEO of the Company, together with his wife and brother, owns 63% of the registered
capital of Ruili Group, and owns more than 50% of the outstanding common stock of SORL. This results in the acquisition being accounted
for using the historical costs of the financial statements of the Ruili Group. The consolidated financial statements, and the Management’s
Discussion and Analysis contained in Item 7 of this report, have been prepared as if the acquisition took place at the earliest
time presented, that is, as of January 1, 2009. The asset purchase was deemed to be the acquisition of a business.
STRATEGIC PLAN
With the increased construction of real
estate and infrastructure and the delayed implementation of the Chinese IV Emission Standard, the China commercial vehicles market
resumed accelerated growth in 2013, after two years of continuous lower growth in 2011 and 2012. The Company’s management
believes the commercial vehicle market will continue to grow in 2014. In 2014, our plan includes these elements:
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Enhance sales to OEM customers. We intend to enhance sales to OEM customers by improving customer
service and increasing sales of integrated systems and modular supplies.
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Focus on bus market. We aim to enhance our relationships with major bus clients in order to achieve
higher sales, to occupy more market share. We have established a team devoted to the development of bus products, so that we can
better respond to the needs of our bus customers and to help achieve higher margins.
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Expand sales into the railway transportation market to further extend the product line. We expect
to develop and supply high value-added products to our railway market customers.
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Develop new products. We plan to enhance the development of several new products including automotive
electronics and energy-saving products. We are working to upgrade traditional air brake drive products to electronically controlled
products to achieve a higher profit margin. We are working to develop energy-saving products which will cause less harm to the
environment, both in the manufacturing process and in use.
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Improve manufacturing technology and further computerize our manufacturing. We expect to continue
to improve our manufacturing process to enhance product quality. We anticipate that improvement of manufacturing technology will
further automate our manufacturing process, thereby reducing human error, increasing manufacturing efficiency, lowering production
costs and further ensuring consistent quality of our products.
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Expand through strategic alliance and acquisitions. We are exploring opportunities to expand our
international sales network through new joint ventures with or acquisitions of other automotive parts manufacturers outside of
China, as well as auto parts distributors or repair factories with established sales networks outside of China. We will seek acquisition
targets that can easily be integrated into our product manufacturing and corporate management, or strong joint-venture partners
that would become major customers.
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THE COMPANY’S PRODUCTS
Through the Joint Venture, the Company manufactures
and distributes automotive brake systems and other key safety related auto parts in China and internationally. Our products are
principally used in different types of commercial vehicles, such as trucks and buses, and include an extensive range of products
covering 65 categories and over 2000 specifications in automotive brake systems. Automotive brake systems and other key safety
related auto parts are critical components to ensure driving safety.
We seek to introduce new products, such
as the braking system products for passenger vehicles and railway vehicles. When working with a customer, our goal is to understand
the need of each customer and apply our extensive experience and innovative technology to deliver products that meet such need.
We support our products with a full-range of styling, design, testing and manufacturing capabilities, including just-in -time and
in-sequence delivery.
ISO 9000 is a family of standards
related to quality management systems and designed to help
organizations ensure that they meet the needs of customers and
other stakeholders. The standards are published by ISO, the International Organization for Standardization, and available through
National standards bodies. ISO 9001 deals with the requirements that organizations wishing to meet the standard have to fulfill.
OHSAS 18001 is an Occupation Health and Safety
Assessment Series for health and safety management systems. It is intended to help organizations to control occupational health
and safety risks. It was developed in response to widespread demand for a recognized standard against which to be certified and
assessed.
The Company obtained ISO9001/QS9000/VDA6.1
System Certifications in 2001. We passed the ISO/TS 16949 System Certification test (an ISO technical specification aiming to develop
a quality management system that provides for continual improvement, emphasizing defect prevention and the reduction of variation
and waste in the supply chain) conducted by the TUV CERT Certification Body of TUV Industries Service GmbH in 2004, and its annual
review in 2013. The ISO/TS 16949 System, a higher standard replacing the ISO9001/QS9000/VDA6.1 System, was enacted by the International
Automotive Task Force and is recognized by major automobile manufacturers all over the world. The annual reviews for other certifications
which we passed in 2012 included ISO14001 on environmental management and OHSAS18001 for health and safety management, reflecting
the Company’s commitment to workplace safety, health and environmental protection.
CHINA AUTOMOBILE AND AUTO PARTS INDUSTRY
Based on statistics published by the China
Association of Automobile Manufactures, China is currently the largest automotive market in the world. The automobile industry
is one of China’s key industries, contributing significantly to the growth of China’s economy.
Based on statistics published by the China
Association of Automobile Manufactures, in 2013 China’s automobile output and sales volume both reached record high levels
of 22.11 million and 21.98 million units, which was increased by 14.8% and 13.9%, compared with 2012 figures. The output and sales
volume of commercial vehicles increased 7.6% and 6.4% to 4.03 million units and 4.06 million units, respectively.
The increase of the overall sales of commercial
vehicles in China in 2013 could be attributed to the acceleration of the growth in capital investment and the further delay of
the Chinese IV Emission Standard, which led to the acceleration of volume of goods transported, as well as the pre-production of
commercial vehicles.
The Chinese auto parts industry is highly
fragmented. Management believes that the future trends of China’s auto parts industry will be:
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To keep pace with the rapid development of new automobile technologies.
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To meet the requirements of increasingly demanding OEM customers, such as zero defects, and cost reduction.
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To partner with OEM customers in the entire process from product design, development and production to cost control, quality
control and final delivery.
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To implement industry restructuring through integration to form several large sized auto parts manufacturing groups better
able to compete with leading international manufacturers.
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MARKET AND CUSTOMERS
We strengthened our sales and marketing
efforts in 2013. The sales person headcount for domestic (PRC) sales and international sales was 53 and 52, respectively. Products
are sold under the “SORL” trademark, which we license on a royalty free basis from the Ruili Group. The Company renewed
the license from Ruili Group in 2012. The license currently expires in 2022 and we have an agreement with the Ruili Group that
the term of the license will be extended if the trademark registration for the trade name is extended.
Management believes that we are the leading
commercial vehicle air brake systems manufacturer in China. In general, the market can be divided into three segments: OEMs in
China, Chinese Aftermarket, and International Market. The above identified markets account for approximately 50.4%, 22.4% and 27.2%,
respectively, of the Company’s annual sales for 2013.
OEM Market -
We have established
long-term business relationships with most of the major vehicle manufacturers in China. We sell our products to approximately 70
major vehicle manufacturers, including all of the key truck manufacturers in China. In addition to heavy-duty trucks, our products
are also widely used in brake systems for buses. Typically, bus manufacturers purchase a chassis from truck chassis manufacturers
which already have incorporated our brake systems.
The table below presents comparative information
for 2013 and 2012 on the Company’s top five OEM customers.
Ranking
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Customer
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% of
2013
Sales
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Customer
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% of
2012
Sales
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1
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Dongfeng Axle Co., Ltd.
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6.3
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%
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Dongfeng Axle Co., Ltd.
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5.5
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%
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2
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FAW Jiefang Automotive Co., Ltd.
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4.8
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%
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FAW Qingdao Automobile Works
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5.3
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%
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3
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FAW Jiefang Qingdao Automotive Co., Ltd.
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4.0
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%
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FAW Jiefang Automotive Co., Ltd.
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3.8
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%
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4
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Dongfeng Axle Co., Ltd. ShiYan Automobile Works
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3.7
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%
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Dongfeng Axle Co., Ltd. ShiYan Automobile Works
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3.3
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%
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5
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Shaanxi Heavy Duty Truck Co., Ltd.
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2.3
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%
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Guangzhou Kormee Vehicle Brake Technology Development Co., Ltd.,
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2.6
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%
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We continue to expand our business
with Beiqi Foton Motor Co.,Ltd., Dongfeng Motor Co.,Ltd, and FAW Group, which were among the commercial vehicle manufacturers
with the highest sales. The Company became a “core supplier” to FAW Group, and a strategic partner with both
Beiqi Foton motor Co., Ltd., and Dongfeng Motor Co., Ltd. (through product co-development contracts and priority supply
agreements). The Company achieved a new business breakthrough with several top tiered vehicle manufacturers such as Sinotruck
and Shaanxi Automobile Group Co., Ltd, as we expanded our businesses with them from supplying only automotive electric
components to delivering entire air-brake systems. Furthermore, Baotou Bei Ben Heavy-Duty Truck and Valin, two fast-growing
companies in the heavy truck market, continued to be our major customers.
Aftermarket -
The Company’s
Chinese sales network consists of 26 authorized distributors covering the following seven regions throughout China: Northeast Region,
North Region, Northwest Region, Southwest Region, Central Region, East Region and South Region.
The 26 authorized distributors sell only
“SORL” products and in turn channel the products through over 2,000 sub-distributors.
International Market –
With
the recovery of the global economy and customers' confidence in the growth of the economy in 2013, our export sales increased compared
to 2012. We consider increasing our export sales as an important way to increase our brand awareness and expand our market share.
We address expansion in the export market through the following measures:
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Focus on both overseas aftermarket and OEM customers at the same time. The Company is selling its products into more than
104 countries and
regions.
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The Company also actively participates in international trade shows including more than ten international exhibitions such
as Automechanika in Frankfort Equip Auto in Pairs, Automotive Aftermarket Products Expo in Las Vegas, Automechanika Middle East
in Dubai and China Import and Export Fair in Guangzhou, to acquire new customers and new orders.
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The Company established a joint venture in Hong Kong in 2009 to focus on expanding SORL’s international sales network
in the Asia-Pacific region and creating a larger footprint in Europe, the Middle East and Africa with a target to create a truly
global distribution network. The Company presently has international sales centers in UAE, USA, Europe. They carry out localization
strategies to meet the different market demands and to strengthen service support.
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In 2013, export sales accounted for 27.2%
of total revenue. Products are exported to more than 104 countries and regions in the world. Total export sales in 2013 increased
by 7.3% compared with 2012.
Ranking
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Country
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Customer Name
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% of
2013
Sales
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Country
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Customer Name
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% of
2012
Sales
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1
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USA
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SAP
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2.6
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%
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USA
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SAP
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3.0
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%
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2
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United Arab Emirates
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GOLDEN
DRAGAN AUTO
SPARE PARTS
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1.9
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%
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United Arab Emirates
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GOLDEN
DRAGAN AUTO
SPARE PARTS
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2.6
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%
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3
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Brazil
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SCHULZ
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1.5
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%
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USA
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RUILI
HYDRAULIC
SYSTEMS
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1.8
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%
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4
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USA
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RUILI HYDRAULIC SYSTEMS
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1.2
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%
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South Africa
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MICO
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0.8
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%
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5
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USA
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CARDONE
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0.9
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%
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Brazil
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LNG
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0.8
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%
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6
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South Africa
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TPE
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0.8
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%
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South Africa
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POLMO
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0.7
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%
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7
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Brazil
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LNG
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0.8
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%
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Spain
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AIR-FREN
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0.6
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%
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COMPETITION
We conduct our business in a complex and
highly competitive industry. The global automotive parts industry principally involves the supply of systems, modules and components
to vehicle manufacturers for the manufacture of new vehicles. Additionally, suppliers provide parts to other suppliers for use
in the latter’s product offerings and to the aftermarket for use as replacement or enhancement parts for older vehicles.
Currently, vehicle manufacturers generally only engage in assembling but not manufacturing non-key automotive parts. Rather, they
source these parts through a global network of suppliers. As a result, only those automotive parts manufacturers with large-scale
production capacity, advanced technology and the ability to produce system modules, can supply their products to vehicle manufacturers
directly. The automotive parts industry in China is fragmented and there are many small manufacturers which mainly target the aftermarket.
However, there are not many companies that have established both nationwide aftermarket sales networks and close relationships
with leading OEM manufacturers. As the largest commercial vehicle air brake system manufacturer in China, we have established long-term
business relationships with many major automotive manufacturers in China, such as FAW Group (a.k.a. First Auto Group), Dongfeng
Motors Group, Beiqi Foton Motor Co., Ltd., Baotou North-Benz Heavy Duty Truck Co., Ltd. and Anhui Jianghuai Automobile Co., Ltd.
Management believes that the key for a successful commercial vehicle air brake supplier are product quality, price competitiveness,
development capability, new product development capacity, and timeliness of delivery. We have strived to improve our competitiveness
by recruiting highly qualified managers and employees, improving our product design capability and facilities, and providing better
customer service.
Domestic Competition -
Our major
competitors in China are: VIE and CAFF, each as described below.
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China VIE Group, or VIE: Its principal products are main valves and unloader/governors, with a majority supplied to OEM’s,
such as Anhui Jianghuai Automobile Co., Ltd., and the remaining portion supplied to the aftermarket and export.
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Chongqing CAFF Automobile Braking and Steering Systems Co., Ltd., or CAFF: Its main products are air dryers and main valves.
Its principal customer is Chongqing Heavy Vehicle Group Co., Ltd.
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We believe the Company has the
following competitive advantages:
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Brand Name: As China’s largest (by sales volume) commercial vehicle air brake systems manufacturer, our “SORL”
brand is widely known nationwide.
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Technology: We view technological innovation and leadership as the critical means to enhance our core competence. Our technology
center includes a laboratory specializing in the research of automotive brake controlling technologies and development of air brake
system products. We are in the final stage of completing our new state-of-the-art testing center equipment in 2013, which improved
system test capability.
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Product Development: Because management believes that our products ultimately define our success, we continue to increase our
budget for research and development activities. Through our international sales offices in the US, the Middle East and Europe we
are able to promptly collect information about current trends in automotive technologies, which in turn is applied to our new product
development and used to enhance our ability to provide domestic OEMs with advanced products. In addition, our software applications
systems and strict implementation of ISO/TS16949 standards in the development process greatly shorten our development lead time
and improve new product quality. The Company has developed its own independent intellectual property embedded in its air brake
spring chambers. The spring chamber’s structure, performance, and quality have made it one of the Company’s key products
and it enjoys a great deal of success among domestic auto manufacturers.
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China Sales Networks: We have 26 authorized distributors
covering seven regions in China. We help train their sales people and improve their service quality. These authorized distributors
in turn channel “SORL” products through over 2,000 sub-distributors throughout China.
International Competition -
In the
international market, our largest competitors are Wabco Holdings Inc. and Knorr-Bremse Group. While management believes our current
advantage over Wabco Holdings Inc. and Knorr-Bremse Group is our lower pricing, management also believes that the Company’s
product quality and brand awareness are improving. Our competitive advantages over other competitors in the global market are:
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Performance-Cost
Ratio: Our products enjoy lower production costs due to the low labor costs in China.
The Company’s technology and manufacturing improvements; have strengthened our
products’ performance-cost advantage is increasing.
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Quick Adaptation to Local Market: Through our international sales channels in the US, the Middle East and Europe, we have been
able to timely respond to local market needs.
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Diversified Auto Products: In addition to braking system products for commercial vehicles, we also produced key safety products
for passenger vehicles and braking system products for railway vehicles. This integrated product offering helps reduce customers’
transaction costs and gives the customers the incentive to procure such products from us.
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INTELLECTUAL PROPERTY AND INNOVATION CAPACITY
As of December 31, 2013, we had 197 technical
staff members, 75 of whom hold Engineer or Senior Engineer qualifications. Our technical staff included 18 information technology,
120 for new product development and design techniques, 13 for measurement and testing, and the remaining 46 for quality management.
In addition to our own technical force,
we had cooperation arrangements with leading universities in the automotive engineering field, including:
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In 2010, SORL created two new post-doctoral research programs. The first program is a partnership with the Automobile Institute
of Jilin University. This program was established to conduct research on the recovery of electric vehicle braking energy. The second
program is a partnership with the Beijing University of Technology. This program was established to conduct researches on die-casting
aluminum oxide film onto auto parts.
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Tongji University at Shanghai and Harbin Institute of
Technology. We have a contract with each of them for co-development of electronically controlled braking systems and automotive
master cable technology.
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Tsinghua University E-Tech Technology Co., Ltd. and Zhejiang University: We have a contract with each of them for information
technology projects, including the development of application software for product design innovation and production management.
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We have priority rights to acquire the intellectual
properties that are developed pursuant to the arrangements with these universities. The financial arrangements as to amount and
terms of payment vary depending on the type of project. Normally, we make an initial payment in the form of a research grant and
then negotiate a payment upon development of the technology.
We also consulted with the technical staff
of the Ruili Group from time to time on a no-cost basis. We collaborated with other industry research groups, such as the research
centers of FAW Group and Dongfeng Group.
Capitalizing on these resources, we developed
innovative products and technologies, such as a new type of clutch servo with sensor; a combined air dryer with a built in temperature-control
device and unloader; and an inner-breath spring chamber that enables internal air circulation.
We own a full range of processing equipment
required for the development of new auto part products, including machines for molding, die casting, cutting, pressing and surface
treatment. Furthermore, we are capable of designing and making over 90% of the devices, such as tools, jigs and molds, that are
required for producing prototypes. In addition, the partnership with Tsinghua University and Zhejiang University in developing
software for application in new product design system has resulted in substantial time savings in our new product development cycle.
Patented Technologies
We continued to invest in research and development
(“R&D”) efforts and to pursue patent protection. Currently we own 257 patents and 122 applications for Patent Cooperation
Treaty protection, which is an international agreement for filing patent applications effective in up to 117 countries.
Trademarks
Our principal trademark is “SORL”, which we license
on a non-exclusive royalty free basis from the Ruili Group. The license currently expires in 2022 and we have an agreement with
the Ruili Group that the term of the license will be extended if the trademark registration for the trade name is extended. The
Company renewed the license from Ruili Group on a royalty free basis in 2012. The Ruili Group obtained a registration for “SORL”
from the World Intellectual Property Organization and registered the trademark in the United States in 2007.
PRODUCTION
We own the largest (by sales volume) commercial
vehicle air brake systems manufacturing facility in China. We are seeking to expand our production capacity. The production process
includes fixture, jig and die making, aluminum alloy die casting, metal sheet stamping, numerical control cutting, welding, numerical
control processing, surface treatment, filming, rubber/plastic processing, final assembly and packaging. We have state-of-the-art
manufacturing and testing facilities sourced from the U.S., South Korea, Taiwan and mainland China, including computerized numerical
control processing centers, computerized numerical control lathes, casting, stamping and cutting machines, automatic spraying and
electroplating lines, cleaning machines, automatic assembly lines and three-dimensional coordinate measuring machines and projectors.
We are seeking to realize automation to reduce production cost.
In September 2007, the Joint Venture purchased
land rights, a manufacturing plant and office building with a total floor area of 712,333 square feet, from the Ruili Group. The
Joint Venture previously leased part of the facility from the Ruili Group and occupied approximately 50% of the facility. As a
result of this transaction, our production space is expected to meet our growth demand for the near future.
ENVIRONMENT
In 2006, we were granted
ISO14001 certification on environmental management (ISO 14000 is a family of standards related to environmental management that
exists to help organizations minimize the negative impact of their operations on the environment and comply with applicable environmental
laws, regulations, and rules) and OHSAS18001 certification on health and safety management, which reflects the Company’s
commitment to workplace safety, health and environmental protection. We conduct staff training to enhance awareness of environmental
issues. We seek in all phases of our operations to employ practices for environment friendly production, reduction or prevention
of pollution, and reduction of energy consumption and manufacturing costs. For example, noise intensity is listed as one of the
criteria in the selection of new equipment; waste water is stored, purified and recycled in the production process; and compressing
machines are used in the disposal of aluminum and steel scraps, saving both storage space and power consumption.
RAW MATERIALS
Raw materials used by the Company in the
manufacture of our products primarily include steel, aluminum, other metals, rubber and various manufactured components.
All of the materials we use generally are
readily available from numerous sources. We have not, in recent years, experienced any significant shortages of manufactured components
or raw materials and normally do not carry inventories of these items in excess of what are reasonably required to meet our production
and shipping schedules. Critical raw materials are generally sourced from at least two or more vendors to assure adequate supply
and reasonable price. We maintain relationships with over twenty material suppliers. In 2013, three largest suppliers were Shanghai
Bao Steel Trading Co., Ltd., Hangzhou Tongjia Trading Co., Ltd., and Shanghai Yedi Metal Material Co., Ltd. which together accounted
for 15.3% of the aggregate of raw materials we purchased. Among these companies, only Shanghai Bao Steel Trading Co., Ltd., which
accounted for 5.8%, was the source of more than 5% of total raw material purchases.
When planning a purchase order, we compare
prices of comparable goods quoted by different suppliers to receive the lowest price. In order to secure a favorable purchase price
and subsequently a predictable cost of sales, we generally make a down payment to suppliers.
Normally, the annual purchase plan for raw
materials, such as aluminum ingot and steel sheet, is determined at the beginning of the calendar year according to our OEM customers’
orders and our own forecast for the aftermarket and international sales. Our purchase plans with key suppliers can be revised quarterly.
Our actual requirements are based on monthly production plans. Management believes that this arrangement prevents us from having
excessive inventory when the orders from our customers change.
For raw materials other than steel and aluminum,
we normally maintain from five to seven days of inventory at our warehouse.
DOING BUSINESS IN CHINA
China’s Economy
Management believes that an important factor
that affects the Chinese automobile industry is the country’s economic environment. According to China’s Statistics
Bureau, China’s economic growth slowed down during the last three years, with its GDP growth rate for 2011, 2012 and 2013
was 9.2%, 7.5% and 7.7%, respectively.
The Chinese Legal System
The practical effect of the legal system
in China on our business operations can be viewed from two separate but intertwined considerations. First, as a matter of substantive
law, the laws regarding foreign invested enterprises provide significant protection against government interference. In addition,
these laws to a large extent protect the full enjoyment of the benefits of corporate organizational documents and contracts to
foreign invested enterprise participants. These laws, however, do impose standards concerning corporate formation and governance,
which are not qualitatively different from the general corporation laws of the several states of the United States. The accounting laws in China mandate certain accounting practices, which are not consistent with US Generally Accepted Accounting
Principles (GAAP). The China accounting laws require that an annual “statutory audit” be performed in accordance with
China’s accounting standards and that the books of account of foreign invested enterprise are maintained in accordance with
Chinese accounting laws.
Second, while the enforcement
of substantive rights may appear less certain or reliable than under the legal system in the United States, foreign
invested enterprises and wholly foreign-owned enterprises are Chinese registered companies that enjoy the same status as
other Chinese registered companies in business-to-business dispute resolutions. Because the terms of the respective Articles
of Association of the Joint Venture (“Articles of Association”) provide that all business disputes pertaining to
foreign invested enterprises are to be resolved by the China International Economic and Trade Arbitration Commission applying
Chinese substantive law, the Chinese minority partner in the Joint Venture will not assume a privileged position regarding
such disputes. Any award rendered by this arbitration tribunal is, by the express terms of the respective Articles of
Association, enforceable in accordance with the United Nations Convention on the Recognition and Enforcement of Foreign
Arbitral Awards (1958). Therefore, as a practical matter, although no assurances can be given, the Chinese legal
infrastructure, while different in operation from its United States counterpart, should not present any significant
impediment to the operation of foreign invested enterprises.
Economic Reform Issues
Although the Chinese government owns the
majority of productive assets in China, in the past several years the government has implemented economic reform measures that
emphasize decentralization and encourage private economic activity. Because these economic reform measures may be inconsistent
or ineffectual, there are no assurances that:
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We will be able to capitalize on economic reforms;
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The Chinese government will continue its pursuit of economic reform policies;
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The economic policies, even if pursued, will be successful;
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Economic policies will not be significantly altered from time to time; and
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Business operations in China will not become subject to the risk of nationalization.
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Since 1979, the Chinese government has embarked
reforms of its economic structure. Because many reforms are unprecedented or experimental, they are subject to risks and setbacks.
Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment
or inflation, or in the disparities in per capita wealth between regions within China, could lead to further adjustment of the
reform measures. This refining and adjustment process may negatively affect our operations.
There can be no assurance that the reforms
to China’s economic system will continue or that we will not be adversely affected by changes in China’s political,
economic, and social conditions and by changes in policies of the Chinese government, such as changes in laws and regulations,
measures which may be introduced to control inflation, changes in the rate or method of taxation, imposition of additional restrictions
on currency conversion and remittance abroad, and reduction in tariff protection and other import restrictions.
EMPLOYEES AND EMPLOYMENT AGREEMENTS
The Company currently employs 3,170 employees,
all of whom are employed full time: 80 for quality control, 197 technical staff, 113 sales and marketing staff, 2,738 production
workers and 42 administrative staff. There are employment agreements with all of the employees whereby administrative staff workers
and hourly workers agree to three years of employment. Employment contracts with all employees comply with relevant laws and regulations
of China.
The Joint Venture is subject to regulations
about the Sino-Foreign equity joint venture enterprise labor management. In compliance with those regulations, the Joint Venture’s
management may hire and discharge employees and make other determinations with respect to wages, welfare, insurance and discipline
of employees. The Joint Venture has, as required by law, established special funds for enterprise development, employee welfare
and incentives, as well as a general reserve. In addition, the Joint Venture is required to provide its employees with facilities
sufficient to enable the employees to carry out trade union activities.
DESCRIPTION OF THE JOINT VENTURE
General
The Joint Venture was established on January
17, 2004, pursuant to the terms of the Joint Venture Agreement with the Ruili Group. Below is a description of the material terms
of the Joint Venture.
Management of the Joint Venture
Pursuant to the terms of the Joint Venture
Agreement, the board of directors of the Joint Venture consists of three directors. We have the right to designate two members
of the board and the Ruili Group has the right to designate one member. We also have the authority to appoint the Chairman of the
board. The majority of the board is vested with the authority with respect to operating matters. As a result, we maintain operating
control over the Joint Venture. However, at this time, three of our directors of board, Messrs. Xiao Ping Zhang, Xiao Feng Zhang
and Ms. Shuping Chi, are the founders of the Ruili Group, and therefore there is limited independence between the two entities.
The term of the Joint Venture will expire on March 4, 2019, although we anticipate that we will be able to extend such term. Extension
of the agreement will be subject to negotiation with the Ruili Group and approval of the Chinese government.
Distribution of Profits of the Joint Venture
After providing social welfare funds for
employees and withholding applicable taxes, the profits, if any, of the Joint Venture are available for distribution to the parties
in proportion to their respective capital contributions. Any such distributions must be authorized by the Joint Venture’s
board of directors. To date, the Joint Venture has not distributed any profits and does not anticipate of doing so for the near
term.
Assignment of Interest of the Joint Venture
Any assignment of an interest in the
Joint Venture must be approved by the Chinese government. The Chinese joint venture laws also provide for preemptive rights
and the consent of one Joint Venture party for any proposed assignments by any other Joint Venture party to any other
unrelated third party.
Liquidation of the Joint Venture
Under the Chinese joint venture laws, the
Joint Venture may be liquidated in certain limited circumstances, including the expiration of the ten-year term or any term of
extension, the inability for the joint venture to continue operations due to severe losses, force majeure, or the failure of a
party to honor its obligations under the Joint Venture Agreement or the Articles of Association in such a manner as to impair the
operations of the joint venture. The Chinese joint venture laws provide that, upon liquidation, the net asset value (based on the
prevailing market value of the assets) of a joint venture shall be distributed to the parties in proportion to their respective
registered capital in the joint venture.
Resolution of Disputes Related To the Joint Venture
In the event of a dispute between the parties,
attempts will be made to resolve the dispute through friendly consultation or mediation. In the absence of a friendly resolution,
the parties have agreed that the matter will first be referred to the China International Economic and Trade Arbitration Commission
in Beijing, whose decisions are final and enforceable in Chinese courts.
Expropriation of the Joint Venture
The Chinese joint venture laws provide that
China generally will not nationalize or requisition enterprises in which foreign funds have been invested. However, under special
circumstances, when public interest requires, enterprises with foreign capital may be legally requisitioned and appropriate compensation
will be made.
ITEM 1A. RISK FACTORS
Our business faces many risks. The risks
described below may not be the only risks we face. Additional risks that we do not yet know of, or that we currently think are
immaterial, may also materially impair our business operations or financial results. If any of the events or circumstances described
in the following risks actually occurs, our business, financial condition or results of operations could suffer and the trading
price of our common stock could decline.
If intensification of the current financial crisis and
slowdown of global economies continues, it may promote trade protectionism which would negatively affect our export sales.
As a result of global economic conditions
and little or no growth in many countries, there is a risk of increased international trade protectionism. Many countries set trade
barriers which could negatively affect our export sales, as well as create potential risks for litigation in the countries to which
our products are exported.
Our ability to effectively implement our business strategy
depends upon, among other factors, the successful recruitment and retention of additional highly skilled and experienced management
and other key personnel and we cannot assure that we will be able to hire or retain such employees.
We must attract, recruit and retain a sizeable
workforce of technically competent employees. Our ability to effectively implement our business strategy will depend upon, among
other factors, the successful recruitment and retention of additional highly skilled and experienced management and other key personnel.
These individuals are difficult to find in China and as the economy in China expands, there is increasing competition for skilled
workers. We cannot assure that we will be able to find, hire or retain such employees, or even if we are able to so hire such employees,
that the cost of these employees will not adversely affect our net income.
Certain of our officers and directors have responsibilities
to other businesses in addition to our Company and as a result, conflicts of interest between us and the other activities of those
persons may occur from time to time.
Certain persons serving as our officers
and directors have existing responsibilities and, in the future, may have additional responsibilities, to provide management and
services to other entities in addition to us. In particular, Mr. Xiao Ping Zhang, our Chief Executive Officer is an officer and
a principal stockholder of the Ruili Group, which is engaged in the development, production and sale of various kinds of automotive
parts as well as operating a hotel property and investing in the development of real property in China. The management of our joint
venture is shared with the Ruili Group and therefore there may exist conflicts of interest between us and the Ruili Group in connection
with its operation. Our Joint Venture Agreement provides that the board of directors of the Joint Venture is comprised of three
persons, two of whom are appointed by us. However, at the present time our Chief Executive Officer, Mr. Xiao Ping Zhang, is the
founder of and employed at the Ruili Group. There can be no assurance that in the event of a conflict between us and the Ruili
Group, our interests in the Joint Venture will not be adversely affected, or that our Company’s interests will always be
fairly represented. The Ruili Group also provides certain services to the Company in the form of bank guaranties and licensing
of certain technology. As a result, conflicts of interest between us and the other activities of those persons may occur from time
to time. Our officers and directors are accountable to us and our shareholders as fiduciaries, which requires that such officers
and directors exercise good faith and integrity in handling our affairs. However, the existing responsibilities limit the amount
of times such officers and directors can spend on our affairs.
We are and will continue to be under downward pricing
pressures on our products from our customers and competitors which may adversely affect our growth, profit margins and net income.
We face continuing downward pricing pressure
from our customers and competitors, especially in the sales of replacement parts. To retain our existing customers and gain new
ones, we must continue to keep our unit prices low. In view of our need to maintain low prices on our products, our growth, profit
margins and net income will suffer if we cannot effectively continue to control our manufacturing and other costs.
Our contracts with our customers are generally short-term
and do not require the purchase of a minimum amount, which may result in periods of time during which we have limited orders for
our products.
Our customers generally do not provide us
with firm, long-term volume purchase commitments. Although we enter into manufacturing contracts with certain of our customers
who have continuing demand for a certain product, these contracts state terms such as payment method, payment period, quality standards
and inspection and similar matters rather than provide firm, long-term commitments to purchase products from us. As a result of
the absence of long-term contracts, we could have periods during which we have no or only limited orders for our products, but
will continue to have to pay the costs to maintain our work force and our manufacturing facilities and to meet other fixed costs,
without the benefit of current revenues.
We consistently face short lead times for delivery of
products to customers. Failure to meet delivery deadlines in our production agreements could result in the loss of customers and
damage to our reputation and goodwill.
We enter into production agreements with
our customers prior to commencing production, which reduces our risk of cancellations. However, these production agreements typically
contain short lead times for delivery of products, leading to production schedules that can strain our resources and reduce our
profit margins on the products produced. Although we have increased our manufacturing capacity, we may lack sufficient capacity
at any given time to meet all of our customers’ demands if they exceed production capacity levels. We strive for rapid response
to customer demand, which can lead to reduced purchasing efficiency and increased material costs. If we are unable to sufficiently
meet our customers’ demands, we may lose our customers. Moreover, failure to meet customer demands may impair our reputation
and goodwill.
Because of the short lead times in our production agreements,
we may not be able to accurately or effectively plan our production or supply needs.
We make significant decisions, including
determining the levels of business that we will seek and accept, production schedules, component procurement commitments, facility
requirements, personnel needs, and other resource requirements, based on our production agreements with our customers. Short lead
times of our customers’ commitments to their own customers and the possibility of rapid changes in demand for their products
reduce our ability to estimate accurately the future requirements of those customers for our products. Because many of our costs
and operating expenses are fixed, a reduction in customer demand can harm our sales, margins and operating results. We may also
occasionally acquire raw materials without having customer orders based on a customer’s forecast or in anticipation of an
order and to secure more favorable pricing, delivery or credit terms in view of the short lead times we often have under our customers’
orders. These purchases can expose us to losses from inventory carrying costs or inventory obsolescence.
Our operations depend highly on Mr. Xiao Ping Zhang, our
Chief Executive Officer, and Ms.Jin Rui Yu, our Chief Operating Officer, and a small number of other executives, and the loss of
any such executive could adversely affect our ability to conduct our business.
The success of our operations depends greatly
on a small number of key managers, particularly, Mr. Xiao Ping Zhang and Ms. Jin Rui Yu. The loss of the service of Mr. Zhang,
or any of the other senior executives could adversely affect our ability to conduct our business. Even if we are able to find other
managers to replace any of these managers, the search for such managers and the integration of such managers into our business
will inevitably occur only over an extended period of time. During that time the lack of senior leadership could affect adversely
our sales and manufacturing, as well as our research and development efforts.
We may not be able to respond effectively to rapid growth
in demand for our products and of our manufacturing operations which could adversely affect our customer relations and our growth
prospects.
If we continue to be successful in obtaining
rapid market penetration of our products, we will be required to deliver large volumes of quality products to customers on a timely
basis at a reasonable cost to those customers. Meeting such increased demands will require us to expand our manufacturing facilities,
to increase our ability to purchase raw materials, to increase the size of our work force, to expand our quality control capabilities
and to increase the scale upon which we produce products. Such demands would require more capital and working capital than we currently
have available.
We may not be able to finance the development of new products
which could negatively impact our competitiveness.
Our future operating results will depend
to a significant extent on our ability to continue to provide new products that compare favorably on the basis of cost and performance
with the products of our competitors. Some of our competitors have design and manufacturing capabilities and technologies to produce
products that compete well with our products, particularly in markets outside of China. We are currently conducting research and
development on a number of new products, requiring a substantial outlay of capital. To remain competitive, we must continue to
incur significant costs in product development, equipment, facilities and invest in research and development of new products. These
costs may increase, resulting in greater fixed costs and operating expenses. All of these factors create pressures on our working
capital and ability to fund our current and future manufacturing activities and the expansion of our business.
We receive a significant portion of our revenues from
a small number of customers which may make it difficult to negotiate attractive prices for our products and exposes us to risks
of substantial losses if we lose certain of these customers.
Although no customer individually accounted
for more than 10% of our revenues for the year ended December 31, 2013, our three largest customers accounted for approximately
15.2% and 14.6% of our revenues in 2013 and 2012, respectively. Dependence on a few customers could make it difficult to negotiate
attractive prices for our products and could expose us to the risk of substantial losses if a single major customer stops purchasing
our products.
Our business depends on our ability to protect and enforce
our intellectual property effectively which may be difficult particularly in China.
The success of our business depends on substantial
measure on the legal protection of proprietary rights in technology we hold. Currently we own 257 patents and 122 applications
for Patent Cooperation Treaty protection, which is an international agreement for filing patent applications effective in up to
117 countries. We claim proprietary rights in various unpatented technologies, know-how, trade secrets and trademarks relating
to products and manufacturing processes. We protect our proprietary rights in our products and operations through contracts, including
nondisclosure agreements. If these contractual measures fail to protect our proprietary rights, any advantage that those proprietary
rights provide to us would be negated. Monitoring infringement of intellectual property rights is difficult, and we cannot be certain
that the steps we have taken will prevent unauthorized use of our intellectual property and know-how, particularly in China and
other countries in which the laws may not protect our proprietary rights as fully as the laws of the United States. Accordingly,
other parties, including competitors, may improperly duplicate our products using our proprietary technologies. Pursuing legal
remedies against persons infringing our patents or otherwise improperly using our proprietary information is a costly and time
consuming process that would divert management’s attention and other resources from the conduct of our other business, and
could cause delays and other problems with the marketing and sales of our products, as well as delays in deliveries.
It may be difficult to find or integrate acquisitions
which could have an adverse effect on our expansion plans.
An important component of our growth strategy
is to invest in or acquire companies such as other automotive parts manufacturers and distribution companies. We may be unable
to identify suitable investment or acquisition candidates, or to make these investments or acquisitions on a commercially reasonable
basis, if at all. If we complete an investment or acquisition, we may not realize the anticipated benefits from the transaction.
Integrating an acquired company is complex,
distracting and time consuming, as well as a potentially expensive process. The successful integration of an acquisition would
require us to:
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integrate and retain key management, sales, research and development, and other personnel;
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incorporate the acquired products or capabilities into our offerings both from an engineering and sales and marketing perspective;
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coordinate research and development efforts;
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integrate and support pre-existing supplier, distribution and customer relationships; and
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consolidate duplicate facilities and functions and combine back office accounting, order processing and support functions.
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The geographic distance between the companies,
the complexity of the technologies and operations being integrated and the disparate corporate cultures being combined may increase
the difficulties of combining an acquired company. Acquired businesses are likely to have different standards, controls, contracts,
procedures and policies, making it more difficult to implement and harmonize company-wide financial, accounting, billing, information
and other systems. Management’s focus on integrating operations may distract attention from our day-to-day business and may
disrupt key research and development, marketing or sales efforts.
With the automobile parts markets being highly competitive
and many of our competitors having greater resources than we do, we may not be able to compete successfully.
The automobile parts industry is a highly
competitive business. Criteria for our customers and potential customers include:
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Price/cost competitiveness;
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Reliability and timeliness of delivery;
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New product and technology development capability;
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Degree of global and local presence;
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Effectiveness of customer service; and
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Overall management capability.
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Depending on the particular product market
(OEM or aftermarket) and geographic market, the number of our competitors varies significantly. Many of our competitors have substantially
greater revenues and financial resources than we do, as well as stronger brand names, consumer recognition, business relationships
with vehicle manufacturers, and geographic presence than we have, especially where we intend to enter a new geographic market.
We may not be able to compete favorably and increased competition may substantially harm our competitive position.
Internationally, we face different market
dynamics and competition. We may not be as successful as our competitors in generating revenues in international markets due to
the lack of recognition of our brands, products or other factors. Developing product recognition overseas is expensive and time-consuming
and our international expansion efforts may be more costly and less profitable than we expect. If we are not able to execute our
business expansion in our target markets, our sales could decline, our margins could be negatively impacted and we could lose market
share.
A disruption at our sole manufacturing site would significantly
interrupt our production capabilities, which could have drastic consequences to us, including threatening our financial viability.
We currently manufacture all of our products
at our sole commercial manufacturing facility, which is located near Ruian City, Wenzhou, Zhejiang Province, People’s Republic
of China. Accordingly, we face risks inherent in operating a single manufacturing facility, since any disruption, such as a fire,
or natural disaster, could significantly interrupt our manufacturing capability. We currently do not have alternative production
plans in place or disaster-recovery facilities available. In case of a disruption, we will have to establish alternative manufacturing
sources. This would require substantial capital on our part, which we may not be able to obtain on commercially acceptable terms
or at all. Additionally, we would likely experience months or years of production delays as we build or locate replacement facilities
and seek and obtain necessary regulatory approvals. If this occurs, we will be unable to satisfy customer orders on a timely basis,
if at all. Also, operating any new facilities may be more expensive than operating our current facility. For these reasons, a significant
disruptive event at our manufacturing facility could have drastic consequences on us, including threatening our financial viability.
The cyclical nature of commercial vehicle production and
sales could result in a reduction in automotive sales, which could adversely affect our financial liquidity.
Our sales to OEMs depend on automotive commercial
vehicle production and sales by our customers, which are highly cyclical and affected by general economic conditions and other
factors, including consumer spending and preferences. They also can be affected by government policies, labor relations issues,
regulatory requirements, and other factors. In addition, in the last two years, the price of commercial vehicles in China has generally
declined. As a result, the volume of commercial vehicle production in China has fluctuated from year to year, which has caused
fluctuations in the demand for our products.
Increasing costs for manufactured components and raw materials
may adversely affect our profitability.
We use a broad range of manufactured components
and raw materials in our products, including castings, electronic components, finished sub-components, molded plastic parts, fabricated
metal, aluminum and steel, and resins. Because it may be difficult to pass increased prices for these items on to our customers,
a significant increase in the prices of our components and materials could materially increase our operating costs and adversely
affect our profit margins and profitability.
Longer product life of parts may reduce aftermarket demand
for some of our products.
In 2013, approximately 49.6% of our sales
were sales to the aftermarket. The average useful life of original equipment parts has been steadily increasing in recent years
due to improved quality and innovations in products and technologies. The longer product lives allow vehicle owners to replace
parts of their vehicles less often. Additional increases in the average useful life of automotive parts are likely to adversely
affect the demand for our aftermarket products.
We may be subject to product liability and warranty and
recall claims, which may increase the costs of doing business and adversely affect our financial condition and liquidity.
We face an inherent business risk of exposure
to product liability and warranty claims if our products actually or allegedly fail to perform as expected or the use of our products
results, or is alleged to result, in bodily injury and/or property damage. We have not obtained product liability insurance and
therefore may be exposed to potential liability without any insurance. We cannot ensure you that we will not incur significant
costs to defend these claims or that we will not experience any product liability losses in the future. In addition, if any of
our designed products are or are alleged to be defective, we may be required to participate in a recall of such products. We cannot
assure you that the future costs associated with providing product warranties and/or bearing the cost of repair or replacement
of our products will not have an adverse effect on our financial condition and liquidity.
We are subject to environmental and safety regulations,
which may increase our compliance costs.
We are subject to the requirements of environmental
and occupational safety and health laws and regulations in China and other countries where we sell our products. To the extent
that we expect to expand our operations into other geographic areas, we will become subject to such laws and regulations of those
countries as well. We cannot provide assurance that we have been or will be at all times in full compliance with all of these requirements,
or that we will not incur material costs or liabilities in connection with these requirements. The capital requirements and other
expenditures that may be necessary to comply with environmental requirements could increase and become a material expense of doing
business.
Non-performance by our suppliers may adversely affect
our operations by delaying delivery or causing delivery failures, which may negatively affect demand, sales and profitability.
We purchase various types of equipment,
raw materials and manufactured component parts from our suppliers. We would be materially and adversely affected by the failure
of our suppliers to perform as expected. We could experience delivery delays or failures caused by production issues or delivery
of non-conforming products if our suppliers failed to perform, and we also face these risks in the event any of our suppliers becomes
insolvent or bankrupt.
Our commercial viability depends significantly on our
ability to operate without infringing the patents and other proprietary rights of third parties.
In the event that our technologies infringe
or violate the patent or other proprietary rights of third parties, we may be prevented from pursuing product development, manufacturing
or commercialization of our products that utilize such technologies. There may be patents held by others of which we are unaware
that contain claims that our products or operations infringe. In addition, given the complexities and uncertainties of patent laws,
there may be patents of which we know that we may ultimately be held to infringe, particularly if the claims of the patent are
determined to be broader than we believe them to be. As a result, avoiding patent infringement may be difficult.
If a third party claims that we infringe its patents,
any of the following may occur:
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we may become liable for substantial damages for past infringement if a court decides that our technologies infringe upon a
competitor’s patent;
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a court may prohibit us from selling or licensing our product without a license from the patent holder, which may not be available
on commercially acceptable terms or at all, or which may require us to pay substantial royalties or grant cross-licenses to our
patents; and
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we may have to redesign our product so that it does not infringe upon others’ patent rights, which may not be possible
or could require substantial funds or time.
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In addition, employees, consultants, contractors
and others may use the trade secret information of others in their work for us or disclose our trade secret information to others.
Either of these events could lead to disputes over the ownership of inventions derived from that information or expose us to potential
damages or other penalties. If any of these events occurs, our business will suffer and the market price of our common stock will
likely decline.
Our international expansion plans subject us to risks
inherent in doing business internationally.
Our long-term business strategy relies on
the expansion of our international sales outside China by targeting markets, such as Europe and the United States. Risks affecting
our international expansion include challenges caused by distance, language and cultural differences, conflicting and changing
laws and regulations, international import and export legislation, trading and investment policies, foreign currency fluctuations,
the burdens of complying with a wide variety of laws and regulations, protectionist laws and business practices that favor local
businesses in some countries, foreign tax consequences, higher costs associated with doing business internationally, restrictions
on the export or import of technology, difficulties in staffing and managing international operations, trade and tariff restrictions,
and variations in tariffs, quotas, taxes and other market barriers. These risks could harm our international expansion efforts,
which could in turn materially and adversely affect our business, operating results and financial condition.
Risks Related to Doing Business in China
or Owning Shares in China-Based Business
We operate from facilities that are located
in China. Our principal operating subsidiary, Ruili Group Ruian Auto Parts Co., Ltd., is a Sino-Foreign joint venture organized
under the laws of China.
Changes in China’s political and economic policies
and conditions could cause a substantial decline in the demand for our products and services.
Historically, we have derived a substantial
portion of our revenues from China. We anticipate that China will continue to be our primary production location and an important
sales base in the near future and currently almost all of our production assets are located in China. While the PRC government
has pursued economic reforms to transform its economy from a planned economy to a market-oriented economy since 1979, a large part
of the PRC economy is still being operated under varying degrees of control by the PRC government. By imposing industrial policies
and other economic measures, such as restrictions on lending to certain sectors of the economy, control of foreign exchange, taxation
and restrictions on foreign participation in the domestic market of various industries, the PRC government exerts considerable
direct and indirect influence on the PRC economy. Many of the economic reforms carried out by the PRC government are unprecedented
or experimental and are subject to risks and even set-backs. Other political, economic and social factors may also lead to further
adjustments of the PRC reform measures. This refining and adjustment process may not necessarily have a positive effect on our
operations and our future business development. For example, the PRC government has in the past implemented a number of measures
intended to slow down certain segments of the PRC economy that the government believed to be overheating, including placing additional
limitation on the ability of commercial banks to make loans by raising bank reserve-against-deposit rates. Historically, this restrictive
policy on loans had the effect of decreasing infrastructure projects resulting in a decrease in demand for heavy trucks, thus adversely
impacting our product sales to our OEM customers. Because of the negative impact of the Chinese government policies on the truck
manufacturers, we also were required to extend our normal credit terms to certain of these manufacturers. Our operating results
may be materially and adversely affected by changes in the PRC economic and social conditions and by changes in the policies of
the PRC government, such as measures to control inflation, changes in the rates or method of taxation and the imposition of additional
restrictions on currency conversion.
Changes in foreign exchange regulation in China may affect
our ability to pay dividends in foreign currencies.
Currently, the official currency of the
PRC, Renminbi (RMB), is not a freely convertible currency and the restrictions on currency exchanges in China may limit our ability
to use revenues generated in RMB to fund our business activities outside China or to make dividends or other payments in U.S. dollars.
The PRC government strictly regulates conversion of RMB into foreign currencies. Over the years, the PRC government has significantly
reduced its control over routine foreign exchange transactions under current accounts, including trade-and service-related foreign
exchange transactions, foreign debt service and payment of dividends. In accordance with the existing foreign exchange regulations
in China, our PRC joint venture may pay dividends in foreign currencies, without prior approval from the PRC State Administration
of Foreign Exchange, or SAFE, by complying with certain procedural requirements. The PRC government may, however, at its discretion,
restrict access in the future to foreign currencies for current account transactions and prohibit us from converting our RMB-denominated
earnings into foreign currencies. If this occurs, our PRC joint venture may not be able to pay us dividends in foreign currency
without prior approval from SAFE. In addition, conversion of RMB for most capital account items, including direct investments,
is still subject to government approval in China and companies are required to open and maintain separate foreign exchange accounts
for capital account items.
Fluctuation in the value of RMB could adversely affect
the value of, and dividends payable on, our shares in foreign currency terms.
The value of RMB is subject to changes in
PRC government policies and depends to a large extent on China’s domestic and international economic, financial and political
developments, as well as the currency’s supply and demand in the local market. For over a decade from 1994, the conversion
of RMB into foreign currencies, including the U.S. dollar, was based on exchange rates set and published daily by the People’s
Bank of China, the PRC central bank, based on the previous day’s interbank foreign exchange market rates in China and exchange
rates on the world financial markets. The official exchange rate for the conversion of RMB into U.S. dollars remained stable until
RMB was revalued in July 2005 and allowed to fluctuate by reference to a basket of foreign currencies, including the U.S. dollar.
Under the new policy, RMB will be permitted to fluctuate within a band against a basket of foreign currencies. There remains significant
international pressure on the PRC government to adopt a substantially more liberalized currency policy, which could result in a
further and more significant appreciation in the value of RMB against the U.S. dollar. Further revaluations of RMB against the
U.S. dollar may also occur in the future.
The uncertain legal environment in China could limit the
legal protections available to our shareholders.
The PRC legal system is a civil law system
based on written statutes. Unlike the common-law system, the civil law system is a system in which decided legal cases have little
precedential value. In the late 1970s, the PRC government began to promulgate a comprehensive system of laws and regulations to
provide general guidance on economic and business practices in China and to regulate foreign investment. Our PRC joint venture
is a Sino-Foreign joint venture and is subject to laws and regulations applicable to foreign investment in China in general and
laws and regulations applicable to foreign-invested enterprises in particular. China has made significant progress in the promulgation
of laws and regulations dealing with economic matters such as corporate organization and governance, foreign investment, commerce,
taxation and trade. However, the promulgation of new laws, changes of existing laws and abrogation of local regulations by national
laws may have a negative impact on our business and prospects. In addition, as these laws, regulations and legal requirements are
relatively recent and because of the limited volume of published cases, the interpretation and enforcement of those laws, regulations
and legal requirements involve significant uncertainties. These uncertainties could limit the legal protections available to foreign
investors, including our shareholders. For example, it is not clear if a PRC court would enforce in China a foreign court decision
made in any case brought by our shareholders against us in shareholders’ derivative actions.
Moreover, the enforceability of contracts
in China, especially with governmental entities, including state-owned enterprise, is relatively uncertain. If counterparties repudiated
our contracts or defaulted on their obligations, we might not have adequate remedies. Such uncertainties or inability to enforce
our contracts could materially and adversely affect our revenues and earnings.
Our primary source of funds for dividend and other distributions
from our operating subsidiary in China is subject to various legal and contractual restrictions and uncertainties as well as the
practice of such subsidiary in declaring dividends, and our ability to pay dividends or make other distributions to our shareholders
is negatively affected by those restrictions, uncertainties and dividend practices.
We conduct our core business operations
through our PRC joint venture. As a result, our profits available for distribution to our shareholders are dependent on the profits
available for distribution from our PRC joint venture. Under current PRC law, our PRC joint venture is regarded as a foreign-invested
enterprise in China. Although dividends paid by foreign invested enterprises are not subject to any PRC corporate withholding tax,
PRC law permits payment of dividends only out of net income as determined in accordance with PRC accounting standards and regulations.
Determination of net income under PRC accounting standards and regulations may differ from determination under U.S. generally accepted
accounting principles in significant aspects, such as the use of different principles for recognition of revenues and expenses.
Under PRC law, our PRC joint venture is required to set aside 10% of its net income each year to fund a designated statutory reserve
fund until such funds reach 50% of registered share capital. These reserves are not distributable as cash dividends. As a result,
our primary internal source of funds for dividend payments is subject to these and other legal and contractual restrictions and
uncertainties, which in turn may limit or impair our ability to pay dividends to our shareholders although we do not presently
anticipate paying any dividends. Moreover, any transfer of funds from us to our PRC joint venture, either as a shareholder loan
or as an increase in registered capital, is subject to registration with or approval by PRC governmental authorities. These limitations
on the flow of funds between us and our PRC joint venture could restrict our ability to act in response to changing market conditions.
To date, our PRC Joint Venture has not distributed any profits and does not anticipate doing so for the near term.
PRC’s economic reform policies, nationalization
or domestic or global economic conditions could result in a total investment loss in our common stock.
Since 1979, the Chinese government has reformed
its economic systems. Because many reforms are unprecedented or experimental, they are subject to risks and even set-backs. Other
political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation,
or in the disparities in per capita wealth between regions within China, could lead to further adjustment of the reform measures.
This refining and adjustment process may negatively affect our operations.
Although the Chinese government owns the
majority of productive assets in China, in the past several years the government has implemented economic reform measures that
emphasize decentralization and encourage private economic activity. Because these economic reform measures may be inconsistent
or ineffectual, there are no assurances that:
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We will be able to capitalize on economic reforms;
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The Chinese government will continue its pursuit of economic reform policies;
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The economic policies, even if pursued, will be successful;
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Economic policies will not be significantly altered from time to time; and
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Business operations in China will not become subject to the risk of nationalization.
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There can be no assurance that the reforms
to China’s economic system will continue or that we will not be adversely affected by changes in China’s political,
economic, and social conditions and by changes in policies of the Chinese government, such as changes in laws and regulations,
measures which may be introduced to control inflation, changes in the rate or method of taxation, changes affecting currency conversion
and remittance abroad, and changes in tariffs and other import controls. A material change in reforms on economic policy could
cause instability or other harmful results.
Because our principal operating company is organized under
the laws of China, and substantially all of our assets are located in China, our shareholders may experience difficulties in effecting
service of legal process, enforcing foreign judgments or bringing original actions in China against our management and us.
Our joint venture operating company is incorporated
under the laws of China and substantially all of our assets are located in China. In addition, all of our directors and executive
officers reside within China, and substantially all of the assets of these persons are located within China. As a result, it may
not be possible to effect service of process within the United States or elsewhere outside China upon certain directors or executive
officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. Moreover,
China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the United States,
the United Kingdom, Japan or many other countries. As a result, recognition and enforcement in China of judgments of a court in
the United States and any of the other jurisdictions mentioned above in relation to any matter may be difficult or impossible.
Furthermore, an original action may be brought in China against us, our directors, managers, or executive officers. In connection
with any such original action, a Chinese court may award civil liability, including monetary damages. However, there is no assurance
that such judgment can be effectively or timely enforced in China.
It is likely that China will adopt additional environmental
regulations and additional or modified regulations relating to the manufacture, transportation, storage, use and disposal of materials
used to manufacture our products or restricting disposal of waste, which would likely increase our operating costs.
National, provincial and local laws impose
various environmental controls on the manufacture of automotive parts and/or of certain materials used in the manufacture of automotive
parts. Although we believe that our operations are in substantial compliance with current environmental regulations, there can
be no assurance that changes in such laws and regulations will not impose costly compliance requirements on us or otherwise subject
us to future liabilities. In addition, China is experiencing substantial problems with environmental pollution. Accordingly, it
is likely that the national, provincial and local governmental agencies will adopt stricter pollution controls. Any such regulation
relating to the manufacture, transportation, storage, use and disposal of materials used to manufacture our products or restricting
disposal of any waste would likely increase our operating costs.
Risks Related to Our Common Stock
The market price for our common stock may be volatile
which could result in a complete loss of your investment.
The market price for our common stock may
be volatile in response to factors including the following:
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actual or anticipated fluctuations in our quarterly operating results,
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announcements of new products by us or our competitors,
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changes in financial estimates by securities analysts,
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changes in the economic performance or market valuations of other companies involved in the production of automotive parts,
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announcements by our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments,
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additions or departures of key personnel,
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potential litigation, or conditions in the automotive market: macroeconomic conditions or other development in the market,
especially in China.
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In addition, the securities markets have
from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular
companies. These market fluctuations may also materially and adversely affect the market price of our common stock.
We may issue additional shares of our capital stock to
raise additional cash for working capital. If we issue additional shares of our capital stock, our stockholders will experience
dilution in their respective percentage ownership in us.
We may seek to further expand our operations
and therefore we may issue additional shares of our capital stock to raise additional cash for working capital. If we issue additional
shares of our capital stock, our stockholders will experience dilution in their respective percentage ownership in us.
A large portion of our common stock is controlled by a
small number of stockholders and as a result, these stockholders are able to influence the outcome of stockholder votes on various
matters.
A large portion of our common stock is held
by a small number of stockholders. Mr. Xiao Ping Zhang, our Company’s Chief Executive Officer, his wife Ms. Shuping Chi,
and his brother Mr. Xiao Feng Zhang, all of whom are the directors of our board, held approximately 49.7%, 6.2% and 6.2% respectively,
of the Company’s common stock as of December 31, 2013. As a result, these stockholders are able to control the outcome of
stockholder votes on various matters, including the election of directors and other corporate transactions including business combinations.
The occurrence of sales of a large number of shares of
our common stock, or the perception that these sales could occur, may affect our stock price and could impair our ability to obtain
capital through an offering of equity securities.
The occurrence of sales of a large number
of shares of our common stock, or the perception that these sales could occur, may affect our stock price and could impair our
ability to obtain capital through an offering of equity securities. This would have an adverse effect on our business by restricting
access to working capital to fund growth and operations. Furthermore, the comparatively small public float of our common stock
could adversely affect the market price of our common stock.
If we cannot continue to satisfy the Nasdaq Global Market’s
listing maintenance requirements and other Nasdaq rules, our common stock could be delisted, which could negatively affect the
price of our ordinary shares and your ability to sell them.
In order to maintain our listing on the
Nasdaq Global Market, we will be required to comply with Nasdaq rules which include rules regarding minimum shareholders’
equity, minimum share price, and certain corporate governance requirements. We may not be able to continue to satisfy the listing
maintenance requirements of the Nasdaq Global Market and other applicable Nasdaq rules. If we are unable to satisfy the Nasdaq
criteria for maintaining listing, our common stock could be subject to delisting. If our common stock is delisted, trading, if
any, of our common stock would thereafter be conducted in the over-the-counter (OTC) market, in the so-called “OTC Pink”
or on the Financial Industry Regulatory Authority (FINRA)’s Over-the-Counter Bulletin Board (OTCBB). As a consequence of
any such delisting, our share price could be negatively affected and our stockholders would likely find it more difficult to dispose
of, or to obtain accurate quotations as to the prices of, our common stock.
We do not intend to pay dividends on shares of our common
stock in the foreseeable future.
We have never paid cash dividends on our
common stock. Our current board of directors does not anticipate that we will pay cash dividends in the foreseeable future. Instead,
we intend to retain future earnings for reinvestment in our business and/or to fund future acquisitions. Determination of net income
under PRC accounting standards and regulations may differ from determination under U.S. GAAP in significant aspects, such as the
use of different principles for recognition of revenues and expenses. Under PRC law, our PRC joint venture is required to set aside
a portion of its net income each year to fund designated statutory reserve funds.
We may be required to indemnify our officers and directors,
which could result in substantial expenditures, which we may be unable to recoup.
Our Bylaws provide for the indemnification
of our directors, officers, employees, and agents, under certain circumstances, for damages, attorney’s fees and other expenses
incurred by them in any litigation to which they become a party arising from their association with or activities on behalf of
us. Such indemnification obligation could result in substantial expenditures, which we may be unable to recoup.
There can be no assurance that we will have the personnel,
financial resources or expertise to continue to meet requirements of relevant regulations, including requirements by Sarbanes-Oxley
Act.
The US Public Company Accounting Reform
and Investor Protection Act of 2002, better known as Sarbanes-Oxley, was one of the most sweeping laws to affect U.S. publicly
- traded companies in 70 years. Sarbanes-Oxley created a set of complex and burdensome regulations. Compliance with such regulations
imposes substantial burdens in terms of financial expense and commitment of personnel. There can be no assurance that we will have
the personnel, financial resources or expertise to continue to meet requirements of these regulations.