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Edited Transcript of SORL earnings conference call or presentation 15-Nov-19 12:00am GMT

Q3 2019 Sorl Auto Parts Inc Earnings Call

Ruian City, ZHJ Dec 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Sorl Auto Parts Inc earnings conference call or presentation Friday, November 15, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Jin Rui Yu

SORL Auto Parts, Inc. - COO

* Kan Lin Min

SORL Auto Parts, Inc. - Accounting Manager

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Conference Call Participants

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* William R. Gregozeski

Greenridge Global LLC - Founder

* Kevin Theiss;Awaken Advisors

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Presentation

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Operator [1]

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Greetings, and welcome to the 2019 Third Quarter Financial Results Conference Call for SORL Auto Parts. (Operator Instructions)

I would now like to turn the conference over to your host, Kevin Theiss, with Investor Relations. Please go ahead.

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Kevin Theiss;Awaken Advisors, [2]

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Thank you for joining us today, and welcome to SORL Auto Parts 2019 Third Quarter Conference Call. Joining us today are Ms. Jin Rui Yu, SORL's Chief Operating Officer; Mr. Min Kan Lin, Assistant CFO; and Ms. Phyllis Huang, IR Director.

Before we begin, I would like to just remind all listeners that throughout this call, we may make statements that may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

The words believe, expect, anticipate, project, target, optimistic, intend, aim, will or similar expressions are intended to identify forward-looking statements.

All statements other than statements of historical fact are statements that may be deemed forward-looking statements. These forward-looking statements are based on current expectations or beliefs, including, but not limited to, statements concerning SORL Auto Parts' operations and its financial performance and conditions. SORL Auto Parts cautions that these statements, by their nature, involve risks and uncertainties and actual results may differ materially depending on a variety of important factors, including those discussed in SORL Auto Parts' reports with the Securities and Exchange Commission from time to Time. SORL Auto Parts specifically disclaims any obligation to update the forward-looking information in the future. The 2019 third quarter results discussed on today's call are unaudited numbers and all numbers are presented in U.S. dollars under U.S. GAAP.

Ms. Jin Rui Yu, SORL's Chief Operating Officer, will give an overview of the operations for the 2019 third quarter. And then I will return to give the financial results. Thereafter, there will be a question-and-answer session conducted.

Ms. Yu, please begin your prepared remarks.

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [3]

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Good morning, everyone. Thank you, everyone, for joining us today. In the third quarter of 2019, China's GDP growth grew at 6%, down from 6.2% in the second quarter and below the 6.4% in the first quarter of 2019. China's exports decreased by 3.2% in September as economic slowing trend continued and with notable softening in fleet shipments, certainly power generation and the service sector. Concern over trade issues with the United States is also affecting business investments. Overall, auto sales in September 2019 reported the 15th straight month of lower sales. In addition to slower economic growth, the auto market was affected as the government's strict emission standards. The National VI were implemented in a number of larger Chinese cities. The National VI standard is expected to be implemented nationally across China in middle 2020. Retailers are selling their current National V vehicles from their inventories to management -- manage this transition, which is affecting the production of new vehicles.

According to the [sales] reports reported by the China Association of Automobile Manufacturers, in the third quarter of 2019, unit production and sale of commercial vehicles in September were up 4% and 1.9% year-over-year. In August of 2019, the production and sales of commercial vehicles increased by 0.9% in production, but sales were down 2.8% year-over-year. For July 2019, the production and sales of commercial vehicles were down 12.7% and 6.4% year-over-year.

For the first 9 months, the production and sales of commercial vehicle were down 2.1% and 3.4% year-over-year. Despite the slowing economy and auto market, our sales grew by 3.4% to the third quarter record high of USD 112.2 million. Our research and development has created a broad portfolio of advanced brakes production, addressing the needs of the notable commercial vehicle markets. So a combination of advanced production and increasing service network generated 25.3% sales growth in the China aftermarket in third quarter of 2019. The large number of vehicle purchased over the years are coming over warranty, creating opportunity for SORL to become a preferred supplier to a larger base of aftermarket customers.

Our gross profit increased 17.5%, and our gross margin expanded to 27.6% compared with 24.3% for the third quarter of 2018. Net income attributable to stockholders for the third quarter of 2019 was USD 4.2 million or $0.22 per basic and diluted share. While there are challenges ahead, the central government has implemented growth policies to encourage faster growth. Tax cuts, less changing regulations and easier monetary policies are designed to stimulate the economy. And there is hope the U.S.-China trade issue will be solved -- resolved to help both economies.

With that now, let me turn the call to Kevin. Thank you.

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Kevin Theiss;Awaken Advisors, [4]

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Thank you. Net sales for the third quarter of 2019 were $112.2 million, the highest sales for any third quarter in the company's history and compared with $108.6 million in the third quarter of 2018. Revenues from the company's domestic OEM customers were $48.6 million compared with $50.3 million in the third quarter of 2018. Sales in China's domestic aftermarket increased 25.3% year-over-year to $45.6 million from $36.4 million in the third quarter of 2018. The continuing expiration of OEM warranties from prior year's new vehicle sales in China drove the company's aftermarket business.

Revenues from international markets were $18.1 million from $21.8 million in the third quarter of 2018. A softer demand for the commercial vehicles in many international markets negatively affected our international sales.

SORL's commercial vehicle brake sales increased 6.6% year-over-year to $94.9 million and represented 84.6% of total sales in the third quarter of 2019. The sales of passenger vehicle auto parts decreased by 11.6% year-over-year to $17.3 million, which accounted for 15.4% of the total sales for the third quarter of 2019.

Gross profit for the third quarter of 2019 rose by 17.5% to $30.9 million from $26.3 million for the third quarter of 2018. Gross margin for the third quarter was 27.6% compared with a gross margin of 24.3% in the same quarter of 2018. The increase in gross margin was primarily due to higher sales of high-margin electronically controlled products during the third quarter of 2019.

Operating expenses increased by 19.3% to $27.1 million in the third quarter of 2019 from $22.7 million in the third quarter of 2018. As a percentage of revenue, operating expenses were 24.1% in the third quarter of 2019 compared with 20.9% in the third quarter of 2018. The increase in operating expenses was due to higher selling and distribution, general and administrative and research and development expenses.

Selling and distribution expenses rose to $13.9 million from $13.2 million in the same quarter of 2018. As a percentage of revenue, selling and distribution expenses were 12.3% compared with 12.1% of quarterly revenues in the same quarter of 2018.

General and administrative expenses, G&A, for the third quarter of 2019 were $8.2 million or 7.3% of revenue compared with $5.1 million or 4.7% in the third quarter of 2018. The increase in G&A expenses was mainly due to an increase in employee salaries and professional fees.

Research and development expenses, R&D, were $5 million in the third quarter of 2019 compared with $4.5 million in the third quarter of 2018. As a percentage of revenue, R&D was 4.5% in the third quarter of 2019 compared with 4.1% of revenue in the third quarter of 2018.

The company continues to develop new, higher-margin electronically controlled products and upgrade the performance and quality of the company's traditional brake products to capture greater market share.

Interest expenses were $3 million in the third quarter of 2019 compared to $3.3 million in the third quarter of 2018. Decreased interest expenses were mainly due to decreased rates on lower loans outstanding during the third quarter of 2019 compared to the third quarter of 2018.

Income before provision for income taxes was $5 million for the third quarter of 2019 as compared with $7.1 million for the third quarter of 2018. The decrease in income before taxes was primarily due to lower government grants and higher operating expenses. Pretax income margin was 4.5% in the third quarter of 2019 compared with 6.6% in the third quarter of 2018. Provision for income taxes was $0.4 million in the third quarter of 2019 compared with $12.1 million in the third quarter of 2018. The significantly lower taxes in the third quarter of 2019 compared with the third quarter of 2018 were mainly due to a onetime accrued tax of $11 million in the third quarter of 2018 associated with the U.S. tax reform related to the planned dividend distribution from China subsidiaries in order to fulfill the payment of onetime accrued taxes.

Net income attributable to stockholders for the third quarter of 2019 was $4.2 million or $0.22 per basic and diluted share compared with a net loss attributable to stockholders of $5.6 million or $0.29 per basic and diluted share in the third quarter of 2018. Excluding the impact of the onetime accrued taxes related to the U.S. tax reform, net income attributable to stockholders for the third quarter of 2018 would have been $5.4 million or $0.28 per basic and diluted share.

Now we go over to 2019 first 9 months financial performance highlights. Net sales for the first 9 months of 2019 increased 12.5% year-over-year to $387.8 million from $344.8 million for the first 9 months of 2018.

Revenues from the company's China OEM customers increased by 17% to $192.7 million from $164.7 million in the same period in 2018. Revenues in China's domestic aftermarket increased 15.5% to $135.5 million from $117.3 million in the first 9 months of 2018.

Revenues from international markets decreased 4.8% to $59.7 million from $62.7 million in the first 9 months of 2018.

SORL's commercial vehicle brake sales increased 6.6% year-over-year to $319.6 million and represented 82% of total sales in the first 9 months of 2019. The sales of passenger vehicle auto parts were $68.3 million compared to last year's same period and accounted for 17.6% of total sales for the first 9 months of 2019. Gross profit for the first 9 months of 2019 increased 14% to $103.7 million from $91 million in the same period in 2018. Gross margin for the first 9 months of 2019 increased to 26.7% from 26.4% for the first 9 months of 2018. The company's gross margin increased due to higher sales.

Income from operations for the first 9 months of 2019 was $26.6 million with an operating margin of 6.9%.

Net income attributable to stockholders for the first 9 months of 2019 was $18.8 million or $0.97 per basic and diluted share compared with $9.4 million or $0.49 per basic and diluted share in the same period 2018. Excluding the impact of U.S. tax reform, net income attributable to stockholders [for the first 9 months of]

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Unidentified Company Representative, [5]

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Kevin, your voice is too low.

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Kevin Theiss;Awaken Advisors, [6]

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2018 would have been $20.4 million or $1.06 per basic and diluted share.

Now we will highlight a few basic balance sheet and financial items. As of September 30, 2019, the company's cash and cash equivalents were $16.5 million. Total stockholders' equity was $189.1 million at September 30, 2019. The company had working capital of $34.2 million on September 30, 2019. During the third quarter of 2019, the company received over $36 million in repayments of advances to related parties.

For the fiscal year 2019, we reiterate the expectation of annual net sales to be approximately $515 million and net income to be approximately $22 million. These targets are based on the company's current views on the operating and market conditions, which are subject to change.

With that, we'll now open the floor for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of William Gregozeski with Greenridge Global.

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William R. Gregozeski, Greenridge Global LLC - Founder [2]

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You've had a lot of growth coming through the aftermarket channel. Can you talk more about how exactly you're getting this growth? Is it from increased distribution locations or extreme market share that you're grabbing from competitors? Can you just talk a little more about how you're getting this growth?

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Unidentified Company Representative, [3]

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Okay, thank you. (foreign language)

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [4]

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(foreign language)

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Unidentified Company Representative, [5]

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[Interpreted] We increased our product offering, extended our product line in the aftermarket during the third quarter. In the past, our main focus -- in the past many years, our main focus has always been the OEM market. We always provide the best-in-class or the most developed new product to the OEM customers. And we tend to -- because of the -- the focus is mainly in the OEM customers, we tend to overlook the aftermarket demand. Starting from this year, we have shifted our strategy, increased product varieties and product offering in the aftermarket. We see aftermarket customers are -- those products are very well received by those aftermarket customers. We also spent time better studied the market and competitive landscape. And we compared some of the product with our peer customer -- peer competitors' product. And we did some adjustment in pricing. So combining all these factors, we are increasing our market share.

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Kan Lin Min, SORL Auto Parts, Inc. - Accounting Manager [6]

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(foreign language)

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [7]

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(foreign language)

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Unidentified Company Representative, [8]

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[Interpreted] We are also increasing our aftermarket customers. And mainly due to the increase of the extension of the network, we're building out more distributors and resellers.

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William R. Gregozeski, Greenridge Global LLC - Founder [9]

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Okay. How involved are the CEO and the CFO in the day-to-day operations of the business, if at all?

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Unidentified Company Representative, [10]

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(foreign language)

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [11]

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(foreign language)

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Unidentified Company Representative, [12]

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[Interpreted] CEO is very much involved into day-to-day operation. He hosts not only on a weekly meetings, but also production or R&D meetings as well. And today, they were called by one of our largest customer for the supply -- order supply conference in their headquarter. So he had to attend that meeting, and so not able to attend today's call.

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [13]

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(foreign language)

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Unidentified Company Representative, [14]

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[Interpreted] Okay. Also CEO and Chairman Zhang, he is the main person host morning meetings 3 times a week, tends to be -- typically, these meetings are Monday, Wednesday or -- and Thursday or Saturday. We here typically work 6 days a week. And so he holds at least 3 morning meetings a week. And these morning meetings, including topics from production, management, quality review, procurement, technology development and the sales and distribution, including OEM aftermarket as well as international sales. So -- and there are also a number of chat group he's chaired in with different committees to discuss product development and sales and distribution.

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William R. Gregozeski, Greenridge Global LLC - Founder [15]

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Okay. Last question is, as you've grown this year, you've used a lot of cash in operations, a lot of working capital. Why are the terms so bad this year on cash going out of the door on the payables, but you're just not receiving as much from your receivables? You just used a lot more cash to run the business this year than last year.

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Unidentified Company Representative, [16]

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(foreign language)

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [17]

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(foreign language)

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Unidentified Company Representative, [18]

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[Interpreted] On the sales side, as you know, many of our customers are large OEMs and in the commercial vehicle sector in China, most of the -- or the majority of the OEMs are SOE, state-owned enterprise. They're backed by either central government or local municipal or provincial government. So the risk of those companies are relatively low because they're financially resourceful and they are -- tend to be the major job creator and taxpayer in the local government. So they tend to get a lot of fundings from local banks. So financially, they're very stable. And in this environment -- market environment, they tend to extend their payment cycles. We understand this has been the case in -- every time economy experienced a slowdown. But we are working closely with them to make sure these extensions or late payment is not going out of control.

On the other hand, we closely monitoring and controlling the bad debt situation or risks with privately owned, entrepreneur-funded companies. Those companies are in today's environment, are tend to be higher risk. And so whenever they place a large order, we'll require small strict payment terms to mitigate the collection risk.

On the procurement side, however, we are taking a different approach because the -- some of the -- or many of our suppliers are long-term customers, long-term supplier to us. And they are -- many of them are private hold -- privately owned companies, financially are solid, but they are not as resourceful as state-owned company. And so for us to continue to foster that partnership and to support their ongoing wellbeings, we negotiate a better term with them. And we tend to -- we're willing to pay a relatively better payment cycles a little faster. And -- but we are asking a better cost discount and -- price discount. So that gives us a better cost structure going forward. That's also one of the reasons you can see from our quarterly earnings, our gross margin has been relatively stable, and we still come out a industry-leading gross margin. This is one of the contributing factor.

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Operator [19]

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(Operator Instructions) Your next question comes from the line of [Paul Renard], with private investor.

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Unidentified Participant, [20]

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It's been about 6 months since you've announced the appointment of an independent Board -- or Board Committee to review the -- taking the company private, the offer and you also announced the appointment of -- hiring of an external consultant. Can you please advise where you're at in that process?

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Unidentified Company Representative, [21]

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(foreign language)

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Kan Lin Min, SORL Auto Parts, Inc. - Accounting Manager [22]

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(foreign language)

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Unidentified Company Representative, [23]

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[Interpreted] At this point, as you know, the special committee has been formed. They have also proceeded with hiring their financial adviser as well as the legal counsel that's independent to represent shareholders' best interest. And they are still in the process of evaluating the offer tendered by the large shareholder. And we are closely following rules and regulations to make sure we are providing updates to the market as shareholders -- as well as shareholders as soon as we have -- we hit the next milestone. So please tune in with our news release on this matter.

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Unidentified Participant, [24]

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Well, okay. I would hope that considering it's an independent Board committee, that you're also considering other alternatives on behalf of the shareholders. So could you please expand on that? And lastly, I would ask, at the last quarter, I asked the same question, and you indicated you were moving with pace. And given the time line that's transpired, it does not appear that the committee is moving with pace?

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Unidentified Company Representative, [25]

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(foreign language)

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Kan Lin Min, SORL Auto Parts, Inc. - Accounting Manager [26]

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(foreign language)

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Unidentified Company Representative, [27]

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[Interpreted] Okay. So as the management for the company, we are doing our fiduciary duty for the shareholders to safeguard your best interest, and we are providing all the updates, including shareholders' feedback, to the special committee. If you have specific concerns or comment or suggestion, feel free to send it to us and then we can forward to the special committee for further review. And that being said, we are looking forward to your feedback, and we want to work closely with you and -- to address your concerns.

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Unidentified Participant, [28]

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It's been a long time. And again, I think that the special committee should be considering not only the offer from the large shareholder, but also consider looking at other investors, potential investors to purchase the organization. So -- and again, on behalf of the shareholders, I think it's important that you move with pace and you consider, again, other external investors in this process.

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Unidentified Company Representative, [29]

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Got it. Thank you. Let me translate this. (foreign language)

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [30]

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(foreign language)

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Unidentified Company Representative, [31]

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[Interpreted] Yes, point well taken. Thank you for your suggestion, and feel free to send letter to the special committee via us and you can send to the Investor Relation team, external and/or internal, and I will make sure I get to forward it to the special committee.

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Operator [32]

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(Operator Instructions) Our next question comes from [Jim Barren], private investor.

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Unidentified Participant, [33]

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Yes. I have -- I don't know if it's questions, but comments. I'm sort of echoing my concerns that Paul brought up. Somebody in the last conference call -- earning -- quarterly earnings conference call said that the company had gone public a number of years ago, and I've forgotten what the stock price was, I thought he said it was around $12 a share or something like that. I don't remember, but he had expressed some concern around $4.25 being pretty inadequate, that the original investors wouldn't even get their money back. And I would emphasize that you got to go back and look. I don't know where you went public, but if it's anywhere -- anything less than -- or anything more than $4.25 a share, I know this guy said, you're going to have a problem, and I agree with the same thing. I don't know where you were, but it's -- you got to at least offer where you went public originally. So that's a comment. And I'm also concerned about the lack of urgency around this and getting this done and only one person who has significant conflict of interest is looking at taking the company private, which is another problem. So that's one thing.

The other thing is that I am puzzled as to why your CEO is not present for this earnings call. I asked this question last time, and I was given, if it wasn't the exact same reason, it's almost the exact same reason that some large customer had called at the last moment and asked for a meeting. And I've been around the block long enough with public companies that you can ask to delay the meeting by an hour and nobody gets upset. I just find this reason for his missing from these meetings lacking credibility, and I'm very concerned about why he's not part of the seat, he really needs to be. So I am very disappointed. And I just -- I don't want to get into any stronger words, but this is just unacceptable, and he needs to know that. His excuse is just unacceptable. It's just not a real excuse, sorry, but I've been working for public companies for decades, and it's -- never heard of such a thing.

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Unidentified Company Representative, [34]

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Okay, let me translate. (foreign language)

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Kan Lin Min, SORL Auto Parts, Inc. - Accounting Manager [35]

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(foreign language)

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Unidentified Company Representative, [36]

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[Interpreted] For your question on special committee, we are -- according to the rules and regulations by U.S. SEC, we are sampled that special committee. We have done everything to that particular standard. And also that special committee went out and retained very professional financial advisers and legal consults. These are the professionals with substantial track record in reviewing the proposals as well as evaluating the company's valuation as well as the offer pricing, the fairness of the pricing. So all these consider is taking the time because they are fulfilling their duty to make sure everything meets shareholders' best interest. And so with that...

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Unidentified Participant, [37]

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Who is the financial firm and who's the law firm on this?

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [38]

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Doug.

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Unidentified Company Representative, [39]

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[Doug Phillips] is the financial adviser.

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Unidentified Participant, [40]

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Doug Phillips?

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Unidentified Company Representative, [41]

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Yes.

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [42]

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[Gibson].

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Unidentified Company Representative, [43]

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Gibson is the legal counsel.

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Unidentified Participant, [44]

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Gibson?

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Unidentified Company Representative, [45]

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Yes, Gibson. Yes.

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Unidentified Participant, [46]

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All right. Well, anyway, I'm just telling you, I've been a stock market investor for about 47 years now. And I'm not going to claim that I know everything about this, but everything that I'm looking at, and I'd love to see their analysis, but this should be a -- this should be an $8 to $10 stock. Not $4.25, but that's -- this is going to get looked at very closely. I mean you're going to -- if you're not careful, you're going to -- everybody involved with this is going to open themselves up to some legal challenges, shall we say. So...

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Unidentified Company Representative, [47]

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Understood.

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Unidentified Participant, [48]

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Particularly when -- as this one person said, you're looking at one potential person to buy it out, who has a significant conflict of interest. And it's just -- got to really watch it, ma'am. That's all I'm going to tell you. I've seen many of these lawsuits in my day and you're just -- I don't know.

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Unidentified Company Representative, [49]

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Okay. (foreign language)

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Jin Rui Yu, SORL Auto Parts, Inc. - COO [50]

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(foreign language)

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Unidentified Company Representative, [51]

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[Interpreted] As management team, Ms. Yu just commented, as a management team, the offering price by the large shareholder, it's hard for us to comment. We remain independent as well as siding with the majority of the shareholder. And so today's -- your suggestions and comments and concern are well noted. We will pass it on to the special committee.

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Unidentified Participant, [52]

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Yes. I mean I'm already seeing on the Internet here November 2015, Rosen Law Firm started an investigation as to whether the ongoing private proposal is fair to the public shareholders. So you're already being very closely watched. Just saying.

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Operator [53]

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(Operator Instructions) Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Kevin Theiss for closing remarks.

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Kevin Theiss;Awaken Advisors, [54]

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I want to thank everyone for joining us today, and we look forward to speaking with you in the future. Have a good morning. Have a good evening.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]