UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

☐	REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

☒	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2019

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

OR

 

☐	SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                 

Commission file number: 001-35154

 

 

CHINA ZENIX AUTO

INTERNATIONAL LIMITED

(Exact Name of Registrant as Specified in Its Charter)

 

 

N/A

(Translation of Registrant’s Name Into English)

British Virgin Islands

(Jurisdiction of Incorporation or Organization)

No. 1608, North Circle Road State Highway

Zhangzhou, Fujian Province 363000

People’s Republic of China

(Address of Principal Executive Offices)

Martin Cheung

No. 1608, North Circle Road State Highway

Zhangzhou, Fujian Province 363000

People’s Republic of China

Phone (86) 596-2600308

Facsimile (86) 596-2600558

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

NONE

(Title of Each Class and Name of Each Exchange on Which Registered)

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

(Title of Class)		(Trading Symbol)
American Depositary Shares, each representing four ordinary shares, par value US$0.0001 per share, not listed on an exchange		ZXAIY:US

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

NONE

(Title of Class)

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

206,500,000 ordinary shares, par value US$0.0001 per share.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     ☐  Yes    ☒  No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or (15)(d) of the Securities Exchange Act of 1934.    ☐  Yes    ☒  No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  Yes    ☐  No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ☒  Yes    ☐  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		☐		Accelerated filer		☐
Non-accelerated filer		☒		Emerging growth company		☐

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

†	The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.  ☐

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  ☐		International Financial Reporting Standards as issued by the International Accounting Standards Board  ☒		Other  ☐

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:    ☐  Item 17    ☐  Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    ☐  Yes    ☐  No

 

 

 

TABLE OF CONTENTS

 

PART I					3
Item 1.		Identity of Directors, Senior Management and Advisers			3
Item 2.		Offer Statistics and Expected Timetable			3
Item 3.		Key Information			3
Item 4.		Information on the Company			23
Item 4A.		Unresolved Staff Comments			45
Item 5.		Operating and Financial Review and Prospects			45
Item 6.		Directors, Senior Management and Employees			59
Item 7.		Major Shareholders and Related Party Transactions			66
Item 8.		Financial Information			66
Item 9.		The Offer and Listing			67
Item 10.		Additional Information			67
Item 11.		Quantitative and Qualitative Disclosures About Market Risk			74
Item 12.		Description of Securities Other than Equity Securities			75
PART II					76
Item 13.		Defaults, Dividend Arrearages and Delinquencies			76
Item 14.		Material Modifications to the Rights of Security Holders and Use of Proceeds			76
Item 15.		Controls and Procedures			76
Item 16A.		Audit Committee Financial Expert			77
Item 16B.		Code of Ethics			77
Item 16C.		Principal Accountant Fees and Services			78
Item 16D.		Exemptions from the Listing Standards for Audit Committees			78
Item 16E.		Purchases of Equity Securities by the Issuer and Affiliated Purchasers			78
Item 16F.		Change in Registrant’s Certifying Accountants			78
Item 16G.		Corporate Governance			78
Item 16H.		Mine Safety Disclosure			78
PART III					78
Item 17.		Financial Statements			78
Item 18.		Financial Statements			78
Item 19.		Exhibits			79

 

i

INTRODUCTION

Conventions Used in this Annual Report

Unless otherwise indicated, references in this annual report on Form 20-F, or annual report, to:

 

•

“ADRs” are to the American depositary receipts, which evidence our ADSs;

 

•

“ADSs” are to our American depositary shares, each of which represents four ordinary shares;

 

•

“aftermarket” are to the market for sales and replacement of commercial wheels after the sale of a commercial vehicle by an OEM;

 

•

“China” or “PRC” are to the People’s Republic of China, excluding, for the purposes of this annual report only, Taiwan and the special administrative regions of Hong Kong and Macau;

 

•

“commercial vehicles” are to heavy-duty, medium-duty, light-duty and mini trucks, large, medium and small buses and off-road vehicles;

 

•

“commercial wheels” are to steel and/or aluminum wheels used in commercial vehicles;

 

•

“distributors” are to our tier-one and tier-two distributors;

 

•

“Hong Kong” are to the Hong Kong Special Administrative Region of the PRC;

 

•

“OEMs” are to original equipment manufacturers;

 

•

“off-road steel wheels” are to steel wheels typically used in construction and other types of off-road vehicles;

 

•

“off-road vehicles” are to loaders, forklifts, wheel excavators, wheel bulldozers, land levelers and road rollers;

 

•

“ordinary shares” or “shares” are to our ordinary shares, par value US$0.0001 per share;

 

•

“RMB” or “Renminbi” are to the legal currency of the PRC;

 

•

“SEC” are to the Securities and Exchange Commission;

 

•

“steel wheels” are to steel wheels used primarily in commercial vehicles;

 

•

“tier-one distributors” are to distributors with whom we have direct contractual relationships;

 

•

“tier-two distributors” are to distributors that have direct contractual relationships with our tier-one distributors;

 

•

“tubed steel wheels” are to steel wheels designed for commercial vehicles using tires that contain a rubber inner tube;

 

•

“tubeless steel wheels” are to steel wheels designed for commercial vehicles using tubeless tires;

 

•

“United States” or “U.S.” are to the United States of America;

 

•

“US$” or “U.S. dollars” are to the legal currency of the United States; and

 

•

“China Zenix,” “we,” “us,” “our,” “our company” and “our group” are to China Zenix Auto International Limited and, unless otherwise indicated or as the context may otherwise require, our predecessor, Zhengxing Wheel Group Co., Ltd., or Zhengxing Wheel (initially named Fujian Zhengxing Wheel Co., Ltd.), and our consolidated entities.

Reliance on SEC Order Granting Conditional Exemptions Due to Circumstances Related to COVID-19

Pursuant to the SEC order dated March 25, 2020 (Release No. 34-88465), we have elected to extend the due date for the filing of our 2019 annual report on Form 20-F. The order allows certain companies affected by COVID-19 to file its Form 20-F within 45 days after the original filing due date. We filed a current report on Form 6-K on April 9, 2020 stating that we are relying on the order to extend the due date for the filing of our 2019 annual report on Form 20-F and anticipate filing no later than June 14, 2020.

In late 2019, an outbreak of the COVID-19 virus emerged in China. On January 23, 2020, the PRC government began to lockdown key areas of China to limit the spread of this dangerous virus. Widespread travel restrictions were implemented and all non-essential businesses were shuttered in heavily affected areas in China. As the Company is headquartered in China, our operations have been largely suspended since the beginning of the Chinese New Year in late January 2020 through early March of 2020. Our finance team could not carry out their work as previously scheduled and were therefore unable to complete the preparation of our consolidated financial statements and the Form 20-F in time to meet the SEC’s original deadline of April 30, 2020.

Special Note Regarding Forward-Looking Statements

This annual report contains forward-looking statements that relate to our current expectations and views of future events. These statements relate to events that involve known and unknown risks, uncertainties and other factors, including those listed under Item 3D “Key Information—Risk Factors,” which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. You should not place undue reliance on these forward-looking statements.

 

1

In some cases, these forward-looking statements can be identified by words or phrases such as “aim,” “anticipate,” “believe,” “consider,” “continue,” “estimate,” “expect,” “forecast”, “going forward,” “intend,” “ought to,” “plan,” “potential,” “predict”, “project,” “propose,” “seek,” “can,” “could,” “may,” “might,” “will,” “would,” “shall,” “should,” “is / are likely to,” and the negative forms of these words or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, among other things, statements relating to:

 

•

the trends, risks, challenges and uncertainties in the automotive industry and commercial wheel industry and for our business generally;

 

•

our beliefs regarding our strengths and strategies;

 

•

our current expansion strategy;

 

•

market acceptance of our products;

 

•

our ability to develop and successfully market new products, including aluminum wheel products;

 

•

our ability to stay abreast of market trends and technological advances;

 

•

competition in the commercial wheel industry;

 

•

our ability to maintain strong working relationships with our distributors and OEM customers;

 

•

our ability to comply with all relevant environmental, health and safety laws and regulations;

 

•

our future prospects, business development, financial condition and results of operations;

 

•

PRC governmental policies and regulations relating to the automotive industry and commercial wheel industry;

 

•

fluctuations in general economic and business conditions in the PRC and international markets;

 

•

the impact of the outbreak of the coronavirus disease, or COVID-19, a disease caused by a novel strain of coronavirus, on the PRC economy and our operations and financial performance; and

 

•

other matters described in this annual report that are not historical facts.

The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events, unless we are required by applicable securities laws and rules to do so. You should read this annual report and the documents that we reference in this annual report and have filed as exhibits to this annual report with the understanding that our actual future results may be materially different from what we expect.

 

2

PART I

 

Item 1.

Identity of Directors, Senior Management and Advisers

Not applicable.

 

Item 2.

Offer Statistics and Expected Timetable

Not applicable.

 

Item 3.

Key Information

 

A.	Selected Financial Data

The following selected consolidated statements of profit or loss and other comprehensive income data for the years ended December 31, 2017, 2018 and 2019 and the selected consolidated statements of financial position data as of December 31, 2018 and 2019 have been derived from our audited consolidated financial statements included elsewhere in this annual report. The following selected consolidated statements of profit or loss and other comprehensive income data for the years ended December 31, 2015 and 2016, and the selected consolidated statements of financial position data as of December 31, 2015, 2016 and 2017 have been derived from our audited consolidated financial statements not included in this annual report. Our audited consolidated financial statements are prepared in accordance with International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board, or IASB.

You should read the selected consolidated financial data in conjunction with our consolidated financial statements and the related notes and Item 5 “Operating and Financial Review and Prospects.” Our historical results are not necessarily indicative of our results expected for any future periods.

 

		Year Ended December 31,
		2015				2016				2017				2018				2019				2019
		RMB				RMB				RMB				RMB				RMB				US$
		(in thousands, except per share data)
Selected Consolidated Statements of Profit or Loss and Other Comprehensive Income Data:
Revenue			2,445,756				2,249,533				2,830,987				3,149,614				2,493,218				358,128
Cost of sales			(2,081,976	)			(1,862,017	)			(2,449,399	)			(2,779,768	)			(2,265,418	)			(325,407	)
Gross profit			363,780				387,516				381,588				369,846				227,800				32,721
Other income, gain and loss			16,410				11,680				21,171				16,089				17,320				2,488
Net exchange (loss) gain			5,793				2,546				(3,521	)			1,250				494				71
Selling and distribution costs			(212,273	)			(181,911	)			(173,800	)			(174,774	)			(155,308	)			(22,309	)
Research and development expenses			(51,253	)			(84,639	)			(57,419	)			(51,760	)			(56,841	)			(8,165	)
Administrative expenses			(136,681	)			(139,377	)			(130,203	)			(144,454	)			(121,647	)			(17,473	)
Finance costs			(15,913	)			(21,387	)			(21,375	)			(23,210	)			(24,435	)			(3,510	)
Profit (loss) before taxation			(30,137	)			(25,572	)			16,441				(7,013	)			(112,617	)			(16,177	)
Income tax (expense) credit			1,570				(352	)			(7,389	)			(969	)			7,747				1,113
Profit (loss) and total comprehensive income (loss) for the year			(28,567	)			(25,924	)			9,052				(7,982	)			(104,870	)			(15,064	)
Profit (loss) and total comprehensive income (loss) attributable to:
Owners of the Company			(28,567	)			(25,924	)			9,052				(7,982	)			(104,870	)			(15,064	)
Earnings (loss) per share
Basic			RMB (0.14)				RMB (0.13)				RMB 0.04				RMB (0.04)				RMB (0.51)				USD (0.07)
Diluted			RMB (0.14)				RMB (0.13)				RMB 0.04				RMB (0.04)				RMB (0.51)				USD (0.07)
Earnings (loss) per ADS
Basic			RMB (0.55)				RMB (0.50)				RMB 0.18				RMB(0.16)				RMB (2.03)				USD (0.29)
Diluted			RMB (0.55)				RMB (0.50)				RMB 0.18				RMB(0.16)				RMB (2.03)				USD (0.29)
Dividend declared and paid per share			—				—				—				—				—				—

 

3

		2015				2016				2017				2018				2019				2019
		RMB				RMB				RMB				RMB				RMB				US$
		(in thousands)
Selected Consolidated Statements of Financial Position Data:
ASSETS
Current assets
Inventories			181,905				138,740				178,034				172,111				129,641				18,622
Trade and other receivables and prepayments			613,418				695,856				900,162				776,473				596,359				85,662
Prepaid lease payments			9,425				9,425				9,425				9,425				—				—
Pledged bank deposits			28,200				32,100				35,200				33,500				14,900				2,140
Fixed bank deposits with maturity period over three months			260,000				290,000				290,000				290,000				290,000				41,656
Bank balances and cash			817,247				896,799				751,612				933,250				906,840				130,259
Total current assets			1,910,195				2,062,920				2,164,433				2,214,759				1,937,740				278,339
Non-current assets
Property, plant and equipment			1,506,318				1,379,287				1,272,774				1,099,003				1,076,731				154,663
Prepaid lease payments			385,874				376,449				367,024				357,599				—				—
Right-of-use assets			—				—				—				—				357,599				51,366
Deferred tax assets			15,958				23,836				25,500				40,272				54,641				7,848
Deposits paid for acquisition of property, plant and equipment			—				—				—				—				61,618				8,851
Intangible assets			17,000				17,000				17,000				17,000				17,000				2,442
Total non-current assets			1,925,150				1,796,572				1,682,298				1,513,874				1,567,589				225,170
Total assets			3,835,345				3,859,492				3,846,731				3,728,633				3,505,329				503,509
EQUITY AND LIABILITIES
LIABILITIES
Current liabilities
Trade and other payables and accruals			606,922				668,633				635,425				611,463				410,764				59,003
Amount due to a shareholder			11,679				1,398				8,742				9,911				10,557				1,516
Taxation payable			674				109				3,573				2,477				982				141
Short-term bank borrowings			558,000				558,000				558,000				473,000				558,000				80,152
Total current liabilities			1,177,275				1,228,140				1,205,740				1,096,851				980,303				140,812
Non-current liabilities
Deferred income			9,292				8,496				7,699				6,903				6,106				877
Deferred tax liabilities			85,284				85,286				86,670				86,239				85,150				12,231
Total non-current liabilities			94,576				93,782				94,369				93,142				91,256				13,108
Total liabilities			1,271,851				1,321,922				1,300,109				1,189,993				1,071,559				153,920
EQUITY
Share capital (US$0.0001 par value, 500,000,000 shares authorized, 206,500,000 shares issued and outstanding as of December 31, 2018 and 2019)			136				136				136				136				136				20
Additional paid in capital			392,076				392,076				392,076				392,076				392,076				56,318
Reserves			2,171,282				2,145,358				2,154,410				2,146,428				2,041,558				293,251
Total equity attributable to owners of the Company			2,563,494				2,537,570				2,546,622				2,538,640				2,433,770				349,589
Total equity and liabilities			3,835,345				3,859,492				3,846,731				3,728,633				3,505,329				503,509

Our business is primarily conducted in the PRC, and most of our revenue is denominated in Renminbi. This annual report contains translations of Renminbi amounts into U.S. dollars at specified rates solely for your convenience. Unless otherwise noted, all translations from Renminbi amounts to U.S. dollar amounts in this annual report were made at the rate of RMB6.9618 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on December 31, 2019.

We make no representation that the Renminbi or U.S. dollar amounts referred to in this annual report could have been or could be converted into U.S. dollars or the Renminbi, as the case may be, at any particular rate or at all.

 

4

B.	Capitalization and Indebtedness

Not applicable.

 

C.	Reasons for the Offer and Use of Proceeds

Not applicable.

 

D.	Risk Factors

Risks Relating to Our Business and Industry

Our operations are affected by the automotive industry in the PRC and our export markets, which in turn are subject to the overall economic environment, government policies and other factors beyond our control.

Our products mainly consist of steel and aluminum wheels for commercial vehicles. Demand for our products is driven by the production and usage of commercial vehicles, which in turn is affected by the prevailing economic conditions, consumption patterns, availability and quality of transportation networks in our target markets. All of these factors are beyond our control. Fluctuations in demand for our products may lead to downward pricing pressure and increased inventory.

Our operations are also sensitive to changes in the government policies relating to all aspects of the automobile industry. The global automotive industry faces uncertainties due to changing geopolitical circumstances and a faltering global trading system. The implementation, renewal, change or cancellation of any government policies in the future, such as economic stimulus or tightening measures or currency controls, in the PRC or in any of our export markets, may significantly affect our business.

Due to the COVID-19 outbreak in China, the PRC government imposed lockdowns and travel restrictions in the first quarter of 2020. The government policies triggered by the outbreak caused major disruptions in the automobile industry. We saw government restrictions beginning to be lifted in mid-March in nearly all provinces and cities as the COVID-19 infections declined dramatically due to enacted government policies. Entering into the second quarter of 2020, lockdown restrictions have been lifted in nearly all provinces and cities in the PRC.

Measures triggered by the outbreak had adversely affected the PRC automobile industry. March 2020 commercial vehicle sales, reflecting the lockdowns in the PRC, declined by 22.6% year-over-year, with buses down 28.0% and trucks dropping 22.1%, according to China Association of Automobile Manufacturers. However, in April 2020, commercial vehicle sales rebounded with growth of 31.6% year-over-year as trucks increased by 34.2% and buses increased by 5.2%, reflecting the opening up of the economy and pent-up demand. We believe that, barring any unforeseen circumstances, the effects of COVID-19 will diminish over the remainder of the 2020 year and the business environment will improve.

If the demand for our steel and aluminum wheels declines as a result of changes in the automotive industry or does not grow at the pace we anticipate, our business, financial condition, results of operations and prospects may be adversely affected.

We do not have multi-year contracts with our major customers.

We rely on our major customers. In 2017, 2018 and 2019, aggregate sales to our five largest customers in our three operating segments—-PRC aftermarket, PRC OEMs and international—-accounted for 24.6%, 26.5% and 24.8% of our revenue, respectively. Anhui Jianghuai Automobile Group is our largest customers and accounted for 9.2%, 8.7% and 8.1% of our revenue for 2017, 2018 and 2019 respectively. Although we generally have longstanding business relationships with our major customers, we do not have multi-year contracts with almost all such customers.

We classify our customers into three groups. The first group consists of PRC distributors that purchase our products for resale to aftermarket end-users, which use our products as replacements for worn out or lower quality wheels in used commercial vehicles. The second group consists of PRC OEMs that purchase our products for incorporation into the commercial vehicles they are producing. The third group consists of international distributors and OEMs. Our contractual relationship with customers is generally defined by the group that they belong:

 

•

For our distributor customers in the PRC, we sign distribution agreements with our tier-one distributors and our exclusive tier-two distributors. These agreements are automatically renewed every year unless terminated by the parties. We do not enter into contracts with our non-exclusive tier-two distributors.

 

5

•

For our OEM customers in the PRC, we sign framework agreements that are renewable every year by mutual agreement. Under these framework agreements, the volume of products to be sold in any given period is not fixed, but the price is fixed and periodically revised based on the market price of steel and/or mutual agreement between the parties.

 

•

For our international customers, we often sign strategic cooperation agreements with our larger customers. These agreements are renewable every three years by mutual agreement. Sales price and volume are specified in individual purchase orders made under the agreements. Other international customers purchase our products pursuant to standalone purchase orders.

None of the contracts with our major customers contain guarantees on minimum sales volumes or prices for multiple years. We therefore cannot assure you that future sales to our major customers would equal or exceed our previous sales or would continue to exist at all. As the existing agreements with our customers expire, we may be unable to renew these agreements with our desired customers on favorable terms in a timely manner or at all. As a result, our business, financial condition, results of operations and prospects may be adversely affected.

Any weakening of our distribution network could lead to a reduction of our revenue or our revenue growth.

PRC aftermarket sales accounted for a significant portion of our revenue. Sales in this operating segment are made to end-users in the aftermarket in the PRC through our nationwide distribution network. As of December 31, 2019, this network consisted of 3,261 distributors in the PRC, including 23 tier-one distributors, 2,120 exclusive tier-two distributors and 1,118 non-exclusive tier-two distributors. Our five largest tier-one distributors accounted for 10.6%, 11.2% and 12.9% of our revenue in 2017, 2018 and 2019, respectively.

Our revenue growth would depend on our ability to engage new distributors and expand volume with existing distributors. We cannot assure you that our business relationships with any of our existing distributors will continue or such existing distributors will purchase our products in the same quantities or at the same prices as in prior years. Competition for distributors in our industry is intense. We compete for distributors against companies that may have greater financial resources or name recognition in certain markets, broader product selection and more favorable pricing than us. If we lose one or more major distributors and are unable to replace them at similar terms in a timely manner or if we fail to develop relationships with new distributors, we may be unable to effectively market and sell our products.

Further, tier-one distributors are not the ultimate end-users of our products. Their orders for our products depend on their downstream sales to tier-two distributors and such distributors’ sales to the ultimate end-users. We cannot be certain that our tier-one distributors will maintain their relationships with tier-two distributors or such tier-two distributors will effectively sell our products to the ultimate aftermarket end-users.

If we fail to maintain our relationship with tier-one distributors; our tier-one distributors fail to maintain relationship with tier-two distributors; or our tier-two distributors fail to effectively sell our products to end-users, our business, financial condition, results of operations and prospect could be adversely affected.

Any breach by our distributors of their agreed arrangements could negatively affect our products sales or subject us to liability.

Our products are sold to the PRC aftermarket through distributors. We divide our distributor customers into two types: tier-one and tier two. Tier-one distributors have contracts with us. These contracts prohibit them from selling commercial wheel products of other manufacturers and require them to sell our products at our suggested prices and in designated sales regions. We generally select our tier-one distributors based on business reputation, size, industry and sales experience, quality of the management team and prior sales performance.

Tier-two distributors source our products from tier-one distributors. Some of our tier-two distributors sell our products on an exclusive basis by sourcing them from the tier-one distributor in their designated sales region. We have annually renewable three-party distribution agreements with exclusive tier-two distributors and their tier-one distributor. These contracts prohibit them from selling commercial wheel products of other manufacturers and require them to follow our branding and marketing requirements. Other tier-two distributors sell our products along with products manufactured by our competitors. We generally do not have contracts with non-exclusive tier-two distributors.

Tier-one distributors and exclusive tier-two distributors are supported by our sales and marketing team. The team also monitors their activities regularly to ensure that they comply with our sales guidelines, policies and procedures. We, however, cannot assure you that our tier-one distributors and exclusive tier-two distributors will fully comply with their contractual obligations to us. For example, they may:

 

•

fail to meet sales targets for our products in accordance with relevant agreement;

 

•

sell our products outside their designated regions, possibly in violation of the exclusive distribution rights specified in the relevant agreement;

 

•

fail to maintain requisite licenses or otherwise comply with regulatory requirements when selling our products;

 

•

sell competing products; or

 

•

violate anti-corruption or other applicable laws during the course of the marketing and sale of our products.

 

6

We have no direct relations with most of our non-exclusive tier-two distributors. Our contracts with tier-one distributors contain our sales policies and restrictions, and we depend on our tier-one distributors to enforce these arrangements against our non-exclusive tier-two distributors. As a result, we have limited ability to manage the activities of our non-exclusive tier-two distributors, and we may not be able to timely mitigate or correct any non-compliance by such distributors with our sales policies and restrictions.

If our distributors do not comply with our agreements with them or if they violate applicable laws or otherwise engage in illegal practices with respect to their sales and marketing of our products, then our brand and reputation may be harmed or our sales activities may be disrupted. We could also be liable for such actions by our distributors.

Our international sales are subject to political or economic challenges such as trade barriers and preferential trade arrangements.

Some of our products are exported to Thailand and more than 30 other countries worldwide. We sell our products in these markets through international distributors, which accounted for 13.7%, 12.4% and 11.5% of our revenue in 2017, 2018 and 2019, respectively. As a result, our operations and financial performance are affected by their social, economic, political and regulatory conditions. Furthermore, regulations and policies affecting trade and bilateral relations between the PRC and the countries and regions to which we export our products can adversely affect our international sales in those countries and regions.

We intend to expand our international sales, particularly sales in Southeast Asia. However, we may not be successful in expanding our international sales or operations or benefiting from any such expansion, due to the following factors:

 

•

fluctuations in foreign exchange rates;

 

•

inability to execute or manage international expansion;

 

•

instability of local political and economic conditions;

 

•

difficulties caused by cultural or language differences;

 

•

inability to timely attract or train sufficient experienced staff and skilled workers in each international market;

 

•

increasing costs and expenses associated with maintaining marketing and sales efforts or establishing other operations outside the PRC;

 

•

difficulty and costs relating to compliance with different commercial and legal requirements of various international markets, including but not limited to any permits, licenses, registrations or certificates that may be required in those markets;

 

•

inability to obtain, maintain or enforce intellectual property rights; and

 

•

trade barriers such as export requirements, tariffs, taxes and other restrictions and expenses (including anti-dumping duties as discussed below), which could increase the prices of our products and make us less competitive in some countries and regions.

Import taxes, anti-dumping duties or other protection measures could have an adverse impact on the prices and sales of our export products and may significantly divert the resources and attention of our management. Furthermore, preferential trade arrangements between our expansion targets and other countries may be a barrier for us to successfully expand our international sales. For example, the member states of ASEAN (i.e. the Association of Southeast Asian Nations, comprising ten countries in Southeast Asia including Vietnam and Thailand) reduced their intra-regional tariff on automobiles from 50% in 2015 to 30% in 2017 through their Free Trade Agreement. The tariff was further reduced to 0% in 2018, which remained the same in 2019, for completely built units of automobiles, resulting in a major challenge for domestic manufacturers and lowering demand for our products.

If we are unable to successfully expand our international sales or operations, our business, financial condition, results of operations and prospects may be materially and adversely affected.

 

7

We may not be able to prevent the distribution of our products to countries, governments, entities or persons targeted by United States economic sanctions, especially when we sell our products to independent non-U.S. distributors over which we have limited control.

The U.S. Department of the Treasury’s Office of Foreign Assets Control administers U.S. economic sanctions, which restrict U.S. persons and, under limited circumstances, foreign entities, in conducting activities, transacting business with or making investments in certain countries, governments, entities and individuals that are the subject of U.S. economic sanctions. U.S. persons are also generally prohibited from facilitating such activities or transactions engaged in by non-U.S. persons.

Historically, a small portion of our export products were sold to independent non-U.S. distributors located in countries subject to U.S. economic sanctions. We ceased selling our products to U.S. sanctioned countries in October 2010 and have implemented measures to prevent any future sales of our products to any sanctions targets. We believe that, under their current terms, U.S. economic sanctions do not apply to our historical activities with respect to the sanctioned countries named above. Due to our limited control over our independent non-U.S. distributors, however, we may be unable to prevent all potential resales or transfers of our products to sanctions targets. We do not always know the end-users to whom our distributors resell our products, and, although we have required our distributors to covenant with us not to resell our products to sanctions targets, one or more of our distributors may breach that covenant.

If our activities are found to violate applicable sanctions or other trade controls, our reputation could be adversely affected, some of our U.S. investors might be required to sell their interests in our company under the laws of certain U.S. states or under internal investment policies or might decide for reputational reasons to sell such interests, and some U.S. institutional investors might forgo the purchase of our ADSs, all of which could materially and adversely affect the value of our ADSs and your investment in us.

We rely on a limited number of suppliers for steel and locking rings, which are materials important to our production.

Steel accounts for a substantial portion of our current total raw material requirements. Our manufacturing process requires us to procure steel that meets certain specifications, and we purchase such steel from a handful of established key suppliers. Although there are alternative steel suppliers in the market, any disruption in steel from our key suppliers may disrupt our manufacturing operations until we can secure customized steel from other suppliers at similar pricing and other terms in a timely manner. We cannot assure you we will always be able to secure customized steels from alternative suppliers in a timely manner at commercially acceptable terms, or at all.

We typically enter into annual supply agreements with our steel suppliers. We cannot assure you that our annual agreements with the relevant suppliers will be renewed on a timely basis, on the same terms as we have previously received or at all. We do not hedge or otherwise fix supply prices in advance by contract, although we typically increase our inventory of steel when prices decline and limit our purchases to the extent possible when steel prices increase. Accordingly, we cannot assure you that we will be able to purchase sufficient quantities of the appropriate types of steel for our various products at the prices we have historically paid.

Locking rings is a key component used in our production of tubed steel wheels. We source a majority of our locking rings from a limited number of suppliers. Similarly, we may be unable to obtain adequate supplies of locking rings at or lower than the prices we have historically paid. If any of the above events occur, our business, financial condition, results of operations and prospects could be adversely affected.

We are subject to risks associated with the volatile prices and availability of raw materials and utilities.

Steel, the key material for our products, is a commodity with frequently fluctuating prices. In addition to steel, utilities, particularly electricity, are another significant input in our manufacturing process. Given the strong sales of our aluminum wheel products and our intention to develop this product segment, our demand for aluminum will increase as well.

Raw materials and utilities are priced based on many factors, such as global demand and supply conditions in the underlying commodities or fuel and economic conditions. Any shortages or interruptions in the supply chain may result in an increase in their prices, and we may not be able to pass on these increases in prices to our customers or find alternative sources at competitive prices. We cannot assure you that such shortages or interruptions will not occur in the future. Alternatively, if the prices of raw materials decrease significantly, especially in the case of steel, which we typically increase our purchases when prices decline, we may have to reduce the prices we charge for our products to remain competitive. This may require us to write down the value of inventory on hand that we purchased prior to such decrease in prices. If any of these events occurs, our business, financial condition, results of operations and prospects may be adversely affected.

 

8

We operate in a highly competitive industry with a relatively small OEM customer base and a trend towards consolidation.

We operate in a highly competitive industry. For our PRC sales, we primarily compete with Shandong Xingmin Wheel, Dongfeng Motor Wheel, Changchun FAWAY Automobile Components, Xiamen Sunrise Wheel and Alcoa Inc, Zhejiang Jingu Company Limited. For our international sales, we primarily compete with local wheel manufacturers in our target markets. Our success depends, among other things, on our ability to maintain and improve our products and production capabilities to meet the needs of our existing and new customers. In particular, there is intense competition for a limited number of OEM customers. If our products do not meet the requirements of our customers, if our competitors offer better products or more competitive prices for similar products or if our products otherwise fail to compete successfully in the industry, our financial performance may be adversely affected.

In addition, there is increasing consolidation within the commercial wheel industry in the PRC. If we fail to maintain or increase our market share, this consolidation in our industry could cause our competitors to develop advantages over us in their available capital, per-unit cost in manufacturing operations, purchasing power with suppliers, pricing power with customers, scale of distribution network, brand recognition and other factors that could adversely affect our business, financial condition, results of operations and prospects.

Changing market trends cause constant shifts in preferences among product types, and we may not react in time to meet varying market demands.

The market for commercial wheels is constantly evolving, with demand for different types of wheels shifting over time. For example, it is anticipated that tubeless steel wheels will gradually displace demand for tubed steel wheels and that there will be a shift from steel wheels to aluminum wheels. These trends are driven by a desire for wheels that provide greater safety and/or fuel efficiency. Successfully meeting the changing market demands will be critical for us to remain competitive in the industry.

Changing market trends may affect our existing and planned products. We anticipate incurring significant costs to appropriately accommodate changing market trends. For example, we have developed new energy-saving and environmentally friendly steel wheels, such as the “Tulou Steel wheel” wheel, and aluminum wheels for various types of vehicles such as high-end minibuses and devoted substantial efforts toward the promotion of these products, including cooperating with large logistics companies in the PRC to allow their customers to test-install and try out our light-weight wheels. We have devoted significant financial and other resources to these activities and expect to incur additional costs in the future.

We may not be successful in keeping up with or foreseeing changing demands in the market, and we may not otherwise realize the full benefit of our investments made in anticipation of any particular market trend. Although we actively engage in research and development activities to keep up with changing market demands, we cannot assure you that we will successfully meet future market demands. Any of these factors could adversely affect our business, financial condition, results of operations and prospects.

Our product development efforts, especially our efforts to develop aluminum wheel products, may not result in successful new products that meet changing market demands.

Product development is important to our competitiveness and business growth. We devote significant resources to enhance our manufacturing processes, improve existing products and introduce new products to meet changing market demands. In particular, we focus on the research and development of aluminum wheels for commercial vehicles.

We launch new projects from time to time as we continue to develop new and enhanced steel wheels and further enhance our research and development efforts in aluminum wheels. As a percentage of revenue, we expect our research and development expenses to remain relatively stable for the foreseeable future. Research and development activities, however, are inherently uncertain, and the success of our new products will depend on a number of factors, including product quality, competition, customer acceptance, price, general market conditions, government policies, our ability to reflect customer feedback into our new products, our ability to accurately assess technological trends and customer needs and the strength of our marketing and distribution capabilities.

We have limited experience in designing and producing aluminum wheels on a commercial scale. We expanded into the aluminum wheel market in 2015, and the market has remained a challenge for us. The production of aluminum wheels differs from that of our existing steel wheel products. For example, aluminum wheels require certain manufacturing equipment and techniques different from those used for steel wheels. Therefore, we may not be successful in the aluminum wheel market. Our competitors may be able to introduce aluminum wheels to markets faster than us, adopt more efficient manufacturing techniques, or develop products that are more effective or commercially attractive than ours. If we fail to succeed in the aluminum wheel market, our business, financial condition, results of operations and prospects may be materially and adversely affected.

 

9

We may not successfully manage utilization rates in our production facilities.

Our future success depends on, among other things, our ability to reach and maintain an optimal production capacity and to maximize the utilization rate of our production capacity. If we fail to achieve either, we may be unable to benefit from economies of scale to decrease our cost per wheel, apply capital efficiently, improve our profitability, maintain our leading competitive position in the commercial wheel industry, or meet customer needs.

As of December 31, 2019, our manufacturing facilities had a designed annual production capacity of approximately 15.5 million units of steel and aluminum wheels, of which 9.5 million units were tubed steel wheels, 5.5 million units were tubeless steel wheels, 33,600 units were off-road steel wheels and 0.5 million units were aluminum wheels.

We have significantly expanded our production capacity and are planning to steadily expand our manufacturing facilities further in the long-term, depending on market conditions. Demand for our products may exceed our production capacity in future periods, in which case we may be required to further expand our production capacity to maintain or increase our market share. However, such future expansion is subject to significant risks and uncertainties, including:

 

•

the need to raise significant additional funds to purchase additional production equipment or to build additional factories, which we may be unable to obtain on commercially viable terms or at all;

 

•

cost overruns and delays as a result of a number of factors, many of which are beyond our control, such as increased costs associated with equipment procurement;

 

•

delays or denial of required approvals by government authorities;

 

•

failures to obtain adequate land or buildings that are suitable for our manufacturing facilities and with geographic proximity to regions with demand for our products or with adequate shipping facilities, utilities and labor pools;

 

•

production inefficiency or inadequate quality control from new or expanded manufacturing facilities;

 

•

inability to quickly implement an adequate set of financial controls to track the increased scale of our business;

 

•

inability to attract, retain or appropriately train and manage new personnel; and

 

•

delays in commencing operations at our new or expanded facilities.

After any expansion of production capacity, the utilization rate of our expanded production capacity may not be satisfactory due to various factors, many of which are beyond our control, including unfavorable market conditions, unanticipated disruptions in our operations, which may impact our ability to manufacture products or make timely deliveries to our customers, and inadequate access to raw materials, labor or other inputs required for our manufacturing operations. As a result, we cannot assure you that we will always be able to adequately utilize our production capacity at any given time. If we fail to appropriately expand and manage our production capacity, our business, financial condition, results of operations and prospects may be adversely affected.

We may seek to expand through acquisitions but may fail in our integration efforts, which could deny us the anticipated benefits from such acquisitions.

To continue our growth, we may acquire businesses, manufacturing facilities, technologies or know-how that we believe would benefit us in terms of product development, manufacturing or distribution.

As we have limited experience with acquisitions, we may experience:

 

•

difficulties in integrating the acquired companies, technologies, personnel or products into our existing business, particularly integrating different quality management, customer relationship management and other business functions;

 

•

delays or failures in realizing the benefits from any acquired company, products or know-how, which could result from, for example, delays in governmental approvals of products developed by acquired businesses;

 

•

diversion of our management’s time and attention from other business concerns;

 

•

higher costs of integration than we anticipated; or

 

•

difficulties in retaining key employees of any acquired business who are necessary to manage these acquisitions.

If we acquire businesses that operate outside the PRC or offer products that are different from our existing products, these risks may increase because of our limited experience in operating such businesses.

An acquisition could also materially impair our results of operations by causing us to incur debt or requiring us to amortize acquired intangible assets. We may also discover deficiencies in internal controls, data adequacy and integrity, product quality and regulatory compliance, and product liabilities in acquired businesses which we did not uncover prior to such acquisition. As a consequence, we may become subject to penalties, lawsuits or other liabilities. Any difficulties in the integration of acquired businesses, product or technologies or unexpected penalties, lawsuits or liabilities in connection with acquired businesses, product or technologies could have a material adverse effect on our business, financial condition and results of operations.

 

10

We depend on the continuing efforts of our executive management team and other key personnel. Losing their services would severely disrupt our business and operations.

Our future success depends substantially on the continuing services of our senior management team, in particular, Mr. Jianhui Lai, our founder, chairman, chief executive officer and controlling shareholder. Mr. Lai has over 20 years of experience in the commercial wheel industry, particularly in managing vehicle wheel businesses. Mr. Lai’s experience and efforts have been instrumental in the development of our company. If Mr. Lai or any of our other senior executives or key personnel are unable or unwilling to remain with our company, we may not be able to replace them with appropriate candidates, our business may be disrupted and our business, financial condition, results of operations and prospects may be materially and adversely affected.

We do not maintain key-man insurance for members of our management team or any of our other key personnel. If we lose the services of any member of our senior management team or key personnel, we may not be able to locate suitable or qualified replacements, and we may incur additional expenses to recruit and train new personnel, which could severely disrupt our business and prospects. In addition, if any member of our senior management team or any of our other key personnel joins a competitor or forms a competing company, we may lose some of our customers and trade secrets. While we generally attempt to protect our trade secrets by entering into non-disclosure, confidentiality and non-competition agreements with our executive officers as well as key personnel who have access to sensitive and confidential information, we cannot assure you that, in light of uncertainties associated with the PRC legal system, these agreements could be enforced in the PRC.

A skilled labor force is important to our business, and our failure to continue to attract, train and retain our highly qualified technical personnel could undermine our long term growth.

Our success will depend, to a significant extent, on our ability to attract, train and retain technical experts, research and development personnel, engineers, post-sales services personnel and sales and marketing personnel, particularly those with expertise and experience in the automotive or automotive component industry. There is substantial competition for those professionals, and there can be no assurance that we will be able to continuously attract or retain them. If we are unable to attract and retain valuable employees, to keep pace with our expected growth, our business, financial condition, results of operations and prospects may be materially and adversely affected.

Labor costs in the PRC may continue to increase.

Labor is a key component of our manufacturing operations. Our total staff costs in 2017, 2018 and 2019 were RMB274.5 million, RMB274.4 million and RMB262.8 million (US$37.8 million), which represented 9.7%, 8.7% and 10.5% of our revenue in each of those years, respectively. Our manufacturing facilities are located in the PRC. As the PRC economy continues to develop, its labor force is becoming more educated and is undergoing other demographic changes. Labor law requirements and changing demographic factors may increase our costs of labor in the PRC.

A significant increase in labor costs for our operations in the PRC could adversely affect our business, financial condition, results of operations and prospects. The number of available workers for our manufacturing operations may decrease. Our current workers may demand higher wages. In addition, increases in the size or number of our competitors or other manufacturing businesses may adversely affect our ability to recruit and retain workers for our own manufacturing operations.

We are subject to credit risks of our customers, and our trade receivables are relatively large.

Our customers may default in their payments to us from time to time. We conduct regular reviews of our credit exposure to our customers. Credit risk arises from events and circumstances beyond our control, and many are difficult to anticipate or detect, such as an economic downturn or deterioration in the financial position of our customers. As of December 31, 2017, 2018 and 2019, we had trade receivables of RMB587.5 million, RMB527.0 million and RMB369.7 million (US$53.1 million), respectively, which represented 20.8%, 16.7% and 14.8% of our revenue in each of those years, respectively.

We offer different credit terms for customers in different operating segments:

 

•

For our PRC aftermarket sales, our tier-one distributors are required to provide us a credit deposit typically equal to approximately one-month of their indicative annual purchase amount. Depending on the actual sales amount, we typically provide our tier-one distributors a credit term of 45 to 55 days from the delivery of our products.

 

•

For our PRC OEM sales, we typically provide our OEM customers a credit term of 90 days from the delivery of our products, depending on the sales amount.

 

•

For our international sales, we typically provide our customers a credit term of 30 days from delivery of our products. For certain new international customers, we require payment of the entire purchase price at the time of purchase.

 

11

If our customers fail to timely pay us, require us to extend credit to them beyond our customary payment periods or otherwise default on their payments in an amount in excess of any previously paid deposit, we may be unable to generate sufficient cash flow to meet our cash flow requirements, and we would need to make provisions for doubtful debts or incur bad debt write-offs, which may adversely affect our financial performance. Disputes which arise due to default in payment by customers may also incur time and substantial costs in claiming for such payments and thus affect our liquidity, business, financial condition, results of operations and prospects.

Our operating results may fluctuate considerably from quarter to quarter, and these fluctuations could have an adverse effect on the price of our ADSs.

Our results of operations have fluctuated in the past and may continue to fluctuate significantly from quarter to quarter as a result of a number of factors, many of which are beyond our control, including:

 

•

seasonal or periodic fluctuations in our customers’ and end-users’ businesses, which could cause variability or unpredictability in the volume and timing of our customers’ purchase orders;

 

•

price fluctuations and shortages of raw materials that we purchase from suppliers;

 

•

our ability to expand our internal production capacity to meet customer demand in a timely and cost efficient manner;

 

•

foreign currency fluctuations, particularly fluctuations in the exchange rates of the Renminbi and U.S. dollar;

 

•

our success in maintaining, establishing and expanding customer relationships;

 

•

changes in our manufacturing costs, selling prices and revenue mix;

 

•

timing of new product or technology developments, announcements, or introductions by us or our competitors and other developments in our competitive environment;

 

•

changes in the regulatory environment of our industry; and

 

•

economic, political and other conditions in the PRC and elsewhere.

Historically, our revenues have typically been higher in the second and fourth quarters and lower in the first and third quarters of each year. We cannot be certain if or how our results of operations will be affected by seasonal trends in future periods.

In addition, if our revenue in a particular quarter is lower than expected, we may be unable to reduce our operating expenses, in particular our advertising and promotion expenses, for that quarter by a corresponding amount. This could have a material adverse effect on our operating results for that quarter. You should not rely on our results from any quarter as an indication of future performance. Quarterly variations in our operations could result in significant volatility in the market for our ADSs. The occurrence of any of the risks described above could result in harm to our business, financial condition, results of operations and prospects, especially if it continues for a period of time or is not mitigated in subsequent periods.

The consequences of the COVID-19 outbreak in the PRC to economic conditions and the automobile industry in general, and the financial position and operating results of our Company in particular, have been material in the first quarter of 2020. The resulting unavoidable lockdowns and travel restrictions in the PRC have caused major disruptions in the automobile industry, affecting customers, supply chains, workers, service networks and other automobile-related occupations as well as a massive disruption to the movement of products and people in the first quarter of 2020. Our operational and financial results during the first quarter of 2020 were adversely affected by these impacts.

Our business operations could remain successful, but we may record a significant charge to earnings if the value of our tangible and intangible assets are impaired due to changes in external factors unrelated to our operations.

We are required under International Financial Reporting Standards to test for impairment on tangible and intangible assets annually or more frequently when events or changes in circumstances indicate the carrying value may not be recoverable. We need to consider information from both external sources (such as market interest rates, significant adverse changes in the technological, market, economic or legal environment in which we operate, market capitalization being lower than net assets) and internal sources (such as internal restructurings, evidence of obsolescence or physical damage to the asset). We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our tangible and intangible assets is determined.

 

12

Our patents, trademarks and other intellectual properties are important assets for our business; if we are unable to protect them, or if other parties claim we are infringing their intellectual property, then our business, financial condition, results of operations and prospects may be materially and adversely affected.

We own a large portfolio of intellectual property rights in the PRC to protect the technologies, inventions and improvements significant to our business, and we believe that this portfolio is important for us to maintain a competitive advantage in the marketplace. As of December 31, 2019, we owned 110 patents in the PRC and 656 trademarks registered with the PRC Trademark Office. We are currently in the process of applying for 8 additional trademarks in the PRC. We also have a number of trademarks and trademark applications in other countries.

Our success will depend in part on our ability to obtain and enforce protection for patents, trademarks and other intellectual property against third-party challenges. Our efforts may not be successful due to the following limitations:

 

•

We will only be able to protect our patents, trademarks and other intellectual properties from unauthorized use by third parties to the extent that we have valid and enforceable intellectual property rights with respect to these properties. Furthermore, the degree of future protection of our intellectual property rights is uncertain because legal means may only provide limited protection and may not adequately protect our exclusive proprietary interest or permit us to gain or keep our competitive advantage.

 

•

We rely primarily on intellectual property laws and contractual arrangements with our employees and others to protect our intellectual property rights. We have entered into agreements with our executive officers and employees involved in technology and research and development, under which intellectual property during most of their employment belongs to us, and they waive all relevant rights or claims to such intellectual property. Generally, our executive officers and employees involved in technology and research and development are also bound by a confidentiality obligation and have agreed to disclose and assign to us inventions conceived by them during their term of employment.

 

•

While we actively take steps to protect our intellectual property rights, such steps may not be adequate to prevent the infringement or misappropriation of our intellectual property. The counterparties to our confidentiality agreements may not follow such agreements, or our confidentiality agreements may not be enforceable or provide an adequate remedy in the event of unauthorized use or disclosure. Infringement or misappropriation of our intellectual property could harm our business and leading market position.

 

•

We have sold, and expect to continue to sell, a significant portion of our products outside the PRC, where we currently have no patent protection . In these jurisdictions, others may obtain patents for substantially equivalent technologies or processes and prevent us from selling any of our products that infringe those foreign patents in those countries.

Our competitors are also developing and seeking patent protection for technologies in connection with the manufacturing of steel wheels. We expect our competitors to continue to take steps to protect these technologies, including seeking patent protection. There may be patents issued or pending held by others that cover significant parts of our technology or business methods. Disputes over rights to these technologies may arise in the future. We cannot be certain that our products do not or will not infringe valid patents or other intellectual property rights held by third parties. As a result, we may be subject to legal proceedings and claims from time to time relating to the intellectual property of others.

If we are not able to protect our patents, trademarks and other intellectual properties, we will not be able to exclude competitors from developing or producing competing products using the relevant technologies or processes. Similarly, if other parties assert claims that we are infringing their intellectual property, they may be able to prevent us from using certain technologies or processes or from producing certain types of products. Any of these situations may adversely affect our business, financial condition, results of operations and prospects.

Our future capital needs are uncertain, and we may not be successful in raising sufficient funds in the future, particularly to fund our expansion activities.

Our business is capital intensive. We believe that our current levels of cash and cash flows from operations, combined with funds available to us through financing will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, we may need additional cash resources in the future if we experience changed business conditions or other developments or if we wish to pursue opportunities for investment, acquisition, strategic cooperation or other similar actions.

Further, our expenditures may exceed our current expectations. Unexpected increases in expenditures could occur for a number of reasons, including, for example, if we devote a significant amount of financial resources to expansion of production capacity or to the research and development of new products or manufacturing techniques that we believe to have significant commercial potential. In particular, we require a significant amount of capital for the expenditures on the purchase of property, plant and equipment.

 

13

Our ability to raise additional funds in the future is subject to a variety of uncertainties, including:

 

•

market conditions for capital-raising activities by PRC-based companies, such as investors’ perception of, and demand for, securities of PRC-based auto component manufacturers;

 

•

the regulatory environment, including regulation of our industry and PRC governmental policies relating to foreign currency borrowings;

 

•

our future financial condition, results of operations and cash flows; and

 

•

economic, political and other conditions in the PRC and elsewhere.

We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds that are necessary for our operations on terms favorable to us could have a material adverse effect on our liquidity and financial condition.

If we raise additional funds, we may dilute existing shareholders or increase our debt, which in turn could restrict our operations or ability to pay dividends.

We have relied on our internal cash and cash generated from our operations to fund our operations and expansion. There can be no assurance that our internal cash and the cash flow generated by our operations will be sufficient to fund our future operations and expansion plans. If our revenue is not sufficient to meet our operational needs and capital requirements or if we have future liquidity needs or other business reasons to seek other sources of funding, we may need (or we may elect) to sell additional equity or debt securities or borrow funds to raise capital. The sale of additional equity or equity-linked securities could result in additional dilution to our shareholders and a reduction in the price of our ADSs. The incurrence of additional debt would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations or our ability to pay dividends. As a result, we may be more vulnerable to general adverse economic and industrial conditions, be limited in our ability to pursue our expansion plans, be required to allocate a significant portion of our cash flow from operations to repay our debts, reducing the availability of our cash flow to fund capital expenditures, working capital and other corporate purposes, and limiting our flexibility in planning for, or reacting to, changes in our business and the market environment.

If we fail to maintain an effective system of internal control over financial reporting, we may lose investor confidence in the reliability of our financial statements, which in turn could negatively impact the trading price of our ADSs or otherwise harm our reputation.

Section 404 of the Sarbanes-Oxley Act of 2002 requires public companies to include a report of management on the effectiveness of such companies’ internal control over financial reporting in their annual reports.

Our management conducted an evaluation of the effectiveness of our internal control over financial reporting and concluded that our internal control over financial reporting was effective as of December 31, 2019. However, if we fail to maintain effective internal control over financial reporting in the future, our management may not be able to conclude that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act of 2002. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial reports. Any failure to maintain effective internal control over financial reporting could also result in the loss of investor confidence in the reliability of our financial statements, which in turn could negatively impact the trading price of our ADSs or otherwise harm our reputation. Furthermore, if we fail to maintain effective internal control over financial reporting in the future, we may also need to incur additional costs and use additional management and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements going forward.

If our manufacturing operations are found to be in violation of any environmental, health and safety regulations, we will be liable for fines and other penalties, including suspending production or ceasing operations, civil or criminal claims resulting in potentially significant monetary damages, adverse publicity and other negative consequences.

Our production process primarily generates and discharges waste water, waste gas, noise and solid waste, and we are required to comply with certain national and local environmental, health and safety regulations. We believe that we have instituted environmental, health and safety procedures and measures that comply with the relevant regulations in the PRC in all material respects. We also sell certain of our solid waste, such as scrap steel, to third parties, including recycling stations. However, we cannot completely eliminate the environmental, health and safety risks associated with our waste materials. If more stringent regulations are adopted in the future, the costs of compliance with these new regulations could be substantial. If we fail to comply with present or future environmental, health and safety regulations, we could be subject to regulatory actions, fines and other penalties, including suspending production or ceasing operations, civil or criminal claims resulting in potentially significant monetary damages, adverse publicity and other negative consequences, all of which could have a material adverse effect on our reputation, business, financial condition, results of operations and prospects.

 

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Our business has benefited from certain PRC government tax incentives, most of which have expired.

Our PRC subsidiaries are subject to PRC enterprise income tax at a statutory rate of 25.0%, except for (i) Zhengxing Wheel, which was recognized as a “High and New Technology Enterprise” and enjoyed a preferential tax rate of 15.0% from 2008 to 2019 (ii) Zhengxing Group Langfang Wheel Co., Ltd., which was recognized as a “High and New Technology Enterprise” and enjoyed a preferential tax rate of 15.0% from 2009 to 2014, (iii) Zhengxing Group Hefei Wheel Co., Ltd., which was recognized as a “High and New Technology Enterprise” and enjoyed a preferential tax rate of 15.0% from 2010 to 2015, (iv) Hua’an Zhengxing Wheel Co. Limited, which was recognized as a “High and New Technology Enterprise” and enjoyed a preferential tax rate of 15.0% from 2017 to 2019 and (v) Zhengxing Group Chengdu Wheel Co., Ltd., which is an entity incorporated in the western region of the PRC in July 2004 and with more than 70.0% of its total income from the business of a state-encouraged industry and is entitled to a preferential tax rate of 15.0% from its date of inception to the end of 2020.

These preferential income tax rates are subject to periodic review and renewal by PRC authorities. If our subsidiaries fail to maintain their preferential tax status, their applicable enterprise income tax (EIT) rate may increase to up to 25.0%, which could have a material adverse effect on our results of operations. We cannot assure you that we will be able to maintain our current effective tax rate in the future.

We also benefit from PRC tax policies designed to encourage exports. In the PRC, steel and aluminum wheels are subject to a value-added tax, or VAT, of 13.0%, but we receive a full rebate of or exemption from the VAT for the steel and aluminum wheels exported by us. The value of these VAT exemptions and rebates amounted to approximately RMB64.4 million, RMB62.3 million and RMB43.4 million (US$6.2 million) in 2017, 2018 and 2019, respectively. However, these VAT exemptions and rebates for exported steel wheels may be eliminated by the PRC government. If this occurs, our business, financial condition, results of operations and prospects may be materially and adversely affected.

We may suffer uncompensated losses from events that disrupt our operations because we do not have adequate insurance.

We currently only maintain insurance covering our major fixed assets, equipment and machinery. Our manufacturing operations are subject to risks including fire, theft, labor disputes, equipment breakdown or failure, natural disasters and non-compliance with the applicable laws or regulations. If any of these events occur at our manufacturing facilities, our manufacturing operations may be materially and adversely disrupted. There is no certainty that our insurance for our major fixed assets, equipment and machinery is sufficient to indemnify us against the losses that may arise from such events. We do not currently maintain insurance coverage for business interruption, product liability or death of key members of management. If an event occurs for which we have inadequate or no insurance coverage, our business, financial condition, results of operations and prospects may be adversely affected.

Risks Relating to Doing Business in the PRC

The PRC has experienced a slowdown in its economic development, and the future performance of the PRC economy could adversely affect our business and prospects.

We conduct most of our business and generate substantially all of our revenues in the PRC. Economic conditions in the PRC are sensitive to global economic conditions, changes in government policies and the expected or perceived overall economic growth rate in the PRC. We expect the PRC economy in the near future to be susceptible to challenges and uncertainties, such as the following:

 

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While the PRC economy has experienced significant growth in the past 30 years, such growth may not continue. The growth rate of the PRC real gross domestic product, or GDP, declined from approximately 7.7% in 2012 to 6.1% in 2019. Because of the domestic and international challenges the PRC faces from time to time, its GDP growth rate may further decline.

 

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COVID-19, a disease caused by a novel strain of coronavirus, has spread globally, and the World Health Organization declared the outbreak of COVID-19 a pandemic on March 13, 2020. The outbreak of the COVID-19 pandemic and its impact could cause a global recession and a significant slowdown in the economic development in many countries, including the PRC, and even long-term economic depression. The global economy may continue to deteriorate in the future. As the PRC is increasingly connected with the rest of the world, any slowdown or decline of global economy could adversely impact its economy in various respects, including reduced exports, decreased consumer spending, higher unemployment levels, lower business confidence and continued volatility of financial markets.

 

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The US-China trade war started in January 2018 and has kept escalating. Both countries have introduced tariffs on goods traded with the other. Despite the phase one trade deal reached between the PRC and the United States, there is no assurance that the trade disputes between the two countries can be fully resolved in the near future. Recently there have been heightened tensions in the economic relations between the United States and the PRC. The adoption and expansion of trade restrictions or other governmental action related to tariffs or trade policies has the potential to adversely impact the PRC economy.

 

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The global macroeconomic environment is facing challenges. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and the PRC. There have been concerns over unrest and terrorist threats in the Middle East, Europe and Africa and over the conflicts involving Ukraine, Syria and North Korea. There have also been concerns on the relationship among the PRC and other Asian countries, which may result in or intensify potential conflicts in relation to territorial disputes. It is unclear whether these challenges and uncertainties will be contained or resolved, and what effects they may have on the global political and economic conditions in the long term.

A deterioration in the PRC business environment due to the slowdown in economic growth could reduce business activities and demand for our products, which could materially and adversely affect our business, financial condition and results of operations.

Changes in government policies in the PRC could adversely affect our business and prospects.

We conduct all of our manufacturing activities in the PRC and have historically derived the majority of our revenue from sales to customers in the PRC. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in the PRC. Although the PRC economy has been transitioning from a planned economy to a more market-oriented economy, it differs from the economies of most developed countries in many respects. A substantial portion of the productive assets in the PRC is still owned by the PRC government, and the PRC government maintains significant control over economic growth through strategically allocating resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.

Our business could be adversely affected by changes in the PRC government’s policies to control the economy. For example:

 

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Measures to control capital investments and curtail the perceived over-capacity of certain industry sectors, such as steel, could affect our supply chain.

 

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Measures to control inflation, including interest rate increases, could decrease economy activities, which could in turn reduce the demand for our products.

 

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Measures in response to the persistent capital outflow and the Renminbi’s depreciation against the U.S. dollar, such as stricter vetting procedures for the PRC-based companies to remit foreign currency for overseas acquisitions could adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business or otherwise fund and conduct our business.

 

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Measures to contain the spread of COVID-19, such as restrictions on inter-province transport, could increase our production and transportation costs and disrupt our product sales.

Any adverse change in government policies in the PRC could have a material and adverse effect on overall economic growth, particularly in the automotive industry in the PRC, which in turn could lead to a reduction in demand for our products and consequently have a material and adverse effect on our businesses.

Uncertainties with respect to the PRC legal system could limit the protections available to our business.

We conduct all of our business through subsidiaries established in the PRC. These subsidiaries are generally subject to laws and regulations applicable to foreign investment in the PRC. Our business is subject to uncertainties under the PRC legal system. For example:

 

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Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in the PRC. Many laws, rules and regulations, however, are relatively new. As the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit the legal protections available to us.

 

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We rely on PRC law-governing contracts and PRC statutes to protect our intellectual property rights, confidentiality and non-compete rights. We may have to resort to administrative and court proceedings to enforce the legal protections that we enjoy. The PRC legal system is a civil law system based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of PRC administrative and court proceedings and the level of legal protection we enjoy in the PRC than in more developed legal systems. These uncertainties may impede our ability to enforce the agreements we have entered into with our business partners, distributors, customers and suppliers. In addition, any litigation in the PRC may be protracted and result in substantial costs and diversion of our resources and management attention.

 

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The PRC legal system is based, in part, on government policies and internal rules. Some of these policies and rules are not published on a timely basis, and some of them may be enforced with a retroactive effect. We therefore may not be aware of a violation of a policy or rule until sometime after the violation. For example, Currently, all governmental approvals relating to our operations and production capacity expansion plans have been issued by the relevant competent local government authorities. However, if a central government agency requires us to obtain its approval and we fail to obtain such approval in a timely manner, or at all, we may be subject to the imposition of fines against us or the suspension or cessation of our production capacity expansion plans.

Such uncertainties, including the inability to enforce our agreements, could materially and adversely affect our business and operations. Further, we cannot predict the effect of future developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to our business.

Fluctuation of the Renminbi could materially affect our financial condition, results of operations and cash flows.

We receive substantially all of our revenues, and our financial statements are presented, in Renminbi. Fluctuations in exchange rates may adversely affect the value, translated or converted into U.S. dollars, of our net assets, earnings and any declared dividends payable on our ordinary shares in foreign currency terms. The value of the Renminbi against U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC and international economic conditions and foreign exchange policies.

The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the People’s Bank of the PRC, or PBOC. Between July 2005 and July 2008, the PRC government allowed the Renminbi to appreciate by more than 20% against the U.S. dollar. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. In August 2015, the PBOC announced that the mid-point exchange rate for the floating range of Renminbi against the U.S. dollar will be determined based on market maker submissions that take into account the Renminbi-U.S. dollar exchange rate at the previous day’s closing of the inter-bank spot foreign exchange market, the supply and demand dynamics and the movements of other major currencies.

Since October 1, 2016, the Renminbi has joined the International Monetary Fund’s basket of currencies that make up the Special Drawing Right, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system and there is no guarantee that the Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the future.

Our financial condition and results of operations may also be affected by changes in the value of certain currencies other than the Renminbi, in which certain of our cash and cash equivalents and bank deposits are denominated. If we incur, in the future, debt denominated in currencies other than the Renminbi, such as in the U.S. dollar, the fluctuation of the Renminbi against the other currencies could adversely affect our financial condition and results of operations. We cannot assure you that any future movements in the exchange rate of the Renminbi against the U.S. dollar or other foreign currencies will not adversely affect our results of operations and financial condition.

The ability of our PRC subsidiaries to make payments to us is subject to PRC regulatory restrictions.

We currently conduct our business through our subsidiaries established in the PRC. We rely on dividends paid by these subsidiaries for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends by entities established in the PRC is subject to limitations. For example:

 

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The Renminbi currently is not a freely convertible currency. Under the “capital account,” which includes, among others, foreign direct investment, prior approval of the State Administration of Foreign Exchange, or SAFE, is needed prior to conversion of Renminbi into foreign currency. On the other hand, under the “current account,” which includes trade, payment of dividends and service-related foreign currency transactions, the Renminbi is currently freely convertible. The ability of our operating subsidiaries in the PRC to satisfy their foreign exchange obligations, pay dividends to us, and obtain foreign exchange through equity financing, including by means of capital contributions from us, depends on the foregoing foreign exchange control regulations in the PRC.

 

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Regulations in the PRC currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in the PRC. Each of our PRC subsidiaries is also required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves or statutory capital reserve fund until the accumulative amount of such reserves reaches 50.0% of its registered capital. Restricted reserves are not distributable as cash dividends. In addition, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. As of December 31, 2019, the accumulated profits of our PRC subsidiaries that were unrestricted and were available for distribution amounted to RMB1,721.0 million (US$247.2 million).

 

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Under the EIT Law and its implementation rules, PRC enterprise income tax at the rate of 10.0% is generally applicable to dividends payable to investors that are “non-resident enterprises,” to the extent such dividends have their sources within the PRC, unless the tax rate is reduced by a tax treaty between the PRC and the relevant jurisdiction. We are a British Virgin Islands holding company, and substantially all of our income may come from dividends we receive from our subsidiary located in Hong Kong, which in turn derives substantially all of its income from our indirect subsidiaries located in the PRC. If our subsidiary in Hong Kong is considered a non-resident enterprise, dividends it receives from the subsidiaries in the PRC will generally be subject to a 10.0% withholding tax under the EIT Law and its implementing rules, or 5.0% withholding tax if the tax treaty between Hong Kong and the PRC is applicable, either of which will reduce the amount of dividends, if any, we may pay to our shareholders and ADS holders.

If we are treated as a resident enterprise for PRC tax purposes under the EIT Law, we will be subject to PRC income tax on our global income.

Under the EIT Law and its implementation rules, enterprises established under the laws of foreign countries or regions whose “de facto management bodies” are located within the PRC territory are considered resident enterprises and will generally be subject to the uniform enterprise income tax at the rate of 25.0% on its global income, which excludes dividends received directly from another PRC resident enterprise. “De facto management bodies” is defined as the bodies that have material and overall management control over the business, personnel, accounts and properties of an enterprise. In April 2009, the State Taxation Administration, or the STA, issued the Notice on Determination of Tax Resident Enterprises of Chinese-controlled Offshore Incorporated Enterprises in accordance with Their De Facto Management Bodies, or Circular 82, that sets forth certain specific criteria for determining whether the “de facto management bodies” are located in the PRC for an offshore incorporated enterprise controlled by PRC enterprises. However, the relevant PRC laws and regulations remain unclear as to how PRC tax authorities will treat an overseas enterprise, with all of its management team members residing in the PRC, invested or controlled by another overseas enterprise as in our case. If we are treated as a resident enterprise for PRC tax purposes, we would be subject to PRC enterprise income tax at the rate of 25.0% on our global income, which could adversely affected our net income and results of operations.

Dividends payable by us to our foreign investors, and gains on the sales of our ordinary shares or ADSs, may be subject to taxes under PRC tax laws, which may materially reduce the value of your investment.

Under the EIT Law and its implementation rules, PRC enterprise income tax at the rate of 10.0% is applicable to dividends payable to investors that are “non-resident enterprises,” which do not have an establishment or place of business in the PRC, or which have such establishment or place of business but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends have their sources within the PRC. Similarly, gains realized on the transfer of ordinary shares or ADSs by such investors are also subject to the 10.0% PRC enterprise income tax if such gains are regarded as income derived from sources within the PRC. We are a British Virgin Islands holding company, and substantially all of our income may come from dividends we receive from our indirect subsidiaries located in the PRC. It is unclear whether the dividends we pay with respect to our ordinary shares or ADSs, or the gains realized on the transfer of our ordinary shares or ADSs, would be treated as PRC-sourced income and be subject to PRC taxes. If we are required under the EIT Law to withhold PRC enterprise income tax on our dividends payable to our non-PRC investors that are “non-resident enterprises,” or if you are required to pay PRC income tax on the transfer of our ordinary shares or ADSs, the value of your investment in our ordinary shares or ADSs may be materially and adversely affected.

 

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Our financial performance and prospects could be affected by natural disasters or health epidemics in the PRC.

Our business could be materially and adversely affected by natural disasters or the outbreak of health epidemics in the PRC. For example, our business and results of operations could be adversely affected by the effects of the outbreak of COVID-19 in the PRC in late 2019. On January 23, 2020, the PRC government began to lockdown key areas of the PRC to limit the spread of this dangerous virus. Widespread travel restrictions were implemented and all non-essential businesses were shuttered in heavily affected areas in the PRC. As we are headquartered in the PRC, our operations have been largely suspended since the beginning of the Chinese New Year in late January 2020 through early March of 2020. In mid-March, the PRC government started easing travel restrictions within the PRC, and we have been gradually ramping up operations to accommodate customer demand. However, the COVID-19 virus has since spread beyond the PRC borders, disrupting global supply chains and hampering consumer confidence and business sentiment. The COVID-19 pandemic has impacted our operating results in the first quarter of 2020 and there is substantial uncertainty as to whether operating results in the second quarter of 2020 could fully return to normal.

We are unable to predict the effect, if any, that any future natural disasters and health and public security hazards may have on our business. Furthermore, such natural disasters and health and public security hazards may severely restrict the level of economic activity in affected areas, which may in turn materially and adversely affect our business and prospects.

U.S. regulatory bodies may be limited in their ability to conduct investigations or inspections of our operations in the PRC.

Any disclosure of documents or information located in the PRC by foreign agencies may be subject to jurisdiction constraints and must comply with the PRC state secrecy laws, which broadly define the scope of “state secrets” to include matters involving economic interests and technologies. There is no guarantee that requests from U.S. federal or state regulators or agencies to investigate or inspect our operations will be honored by us, by entities who provide services to us or with whom we associate, without violating PRC legal requirements, especially as those entities are located in the PRC. Furthermore, under the current PRC laws, an on-site inspection of our facilities by any of these regulators may be limited or prohibited.

Our auditors are currently not inspected fully by the Public Company Accounting Oversight Board.

Our independent registered public accounting firm that issues the audit report included in our annual report filed with the SEC, as auditors of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board, or PCAOB, is required by the laws in the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws in the United States and professional standards. However, because we have substantial operations within the PRC, the PCAOB is currently unable to conduct inspections of the work of our auditors as it relates to those operations without the approval of the PRC authorities. As a result, our auditors are currently not inspected fully by the PCAOB. This current state of affairs carries the following risks:

 

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The inability of the PCAOB to conduct inspections of auditors in the PRC makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of the PRC that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

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Inspections of other firms that the PCAOB has conducted outside the PRC have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in the PRC prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

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Since 2011, the SEC and the PCAOB has sought to obtain access to the audit work papers and related documents from the PRC affiliates of the “big four” accounting firms. The firms were, however, advised and directed that under PRC law, they could not respond directly to the U.S. regulators on those requests, and that requests by foreign regulators for access to such papers in the PRC had to be channeled through the CSRC. The SEC may continue to challenge the four PRC-based accounting firms’ compliance with U.S. laws in connection with U.S. regulatory requests for audit work papers or such challenge could result in the SEC imposing penalties such as suspensions. Depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

 

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In June 2019, as part of a continued regulatory focus in the United States on access to audit and other information currently protected by national law, in particular the PRC, a bipartisan group of lawmakers introduced bills in both houses of the U.S. Congress, which if passed, would require the SEC to maintain a list of issuers for which PCAOB is not able to inspect or investigate an auditor report issued by a foreign public accounting firm. The proposed Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges (EQUITABLE) Act prescribes increased disclosure requirements for these issuers and, beginning in 2025, the delisting from U.S. national securities exchanges of issuers included on the SEC’s list for three consecutive years. The bill is in the first stage of the legislative process. Enactment of this legislation or other efforts to increase U.S. regulatory access to audit information could cause investor uncertainty for affected issuers, including us, and the market price of our ADSs could be adversely affected. It is unclear if this proposed legislation would be enacted.

 

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The PCAOB’s inability to carry out inspections of auditors in the PRC is an issue that has vexed U.S. regulators in recent years. On April 21, 2020, the SEC and the PCAOB issued a joint statement reiterating the greater risk that disclosures will be insufficient in many emerging markets, including the PRC, compared to those made by U.S. domestic companies. In discussing the specific issues related to the greater risk, the statement again highlights the PCAOB’s inability to inspect audit work paper and practices of accounting firms in the PRC, with respect to their audit work of U.S. reporting companies. However, it remains unclear what further actions, if any, the SEC and PCAOB will take to address the problem. There has been recent media reports on deliberations within the U.S. government regarding potentially limiting or restricting the PRC-based companies from accessing U.S. capital markets. If any such deliberations were to materialize, the resulting legislation may have material and adverse impact on the stock performance of the PRC-based issuers listed in the United States.

You may experience difficulties in effecting service of legal process and enforcing judgments against us and our management, and the ability of U.S. authorities to bring actions in the PRC may also be limited.

We are a company incorporated under the laws of the British Virgin Islands, and substantially all of our assets and our subsidiaries are located in the PRC. In addition, most of our directors and officers reside within the PRC, and substantially all of the assets of our directors and officers are located within the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside the PRC upon most of our directors or officers, including with respect to matters arising under applicable laws and regulations. Moreover, the PRC does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the United States, the United Kingdom or most other western countries.

As a result, recognition and enforcement in the PRC of judgments of a court in the United States and any of the other jurisdictions mentioned above in relation to any matter not subject to a binding arbitration provision may be difficult or impossible. Even if you sue successfully in a U.S. court or any of the other jurisdictions mentioned above, you may not be able to collect on such judgment against us or our directors and officers. In addition, the SEC, the U.S. Department of Justice and other U.S. authorities may also have difficulties in bringing and enforcing actions against us or our directors or officers in the PRC.

Risks Relating to Our ADSs

Our ADSs were delisted from the New York Stock Exchange on December 17, 2018 and are currently being quoted on the over-the-counter market.

On June 14, 2018, following an investigation of the trading activity of our ADSs during certain periods in 2015 and 2016, the regulation staff of the New York Stock Exchange, or the NYSE, suspended trading in our ADSs on the NYSE, and initiated delisting proceedings. An NYSE press release announcing the decision cited events “contrary to the public interest and not in keeping with sound public policy, pursuant to Section 802.1D of the [NYSE’s] Listed Company Manual.” On June 28, 2018, we filed a notice to request a hearing to appeal the decision to a Committee of the Board of Directors of the NYSE. The hearing was held on October 11, 2018. On December 4, 2018, the Committee affirmed the determination to delist our ADSs, and the NYSE filed a Form 25 with the SEC on December 6, 2018.

When the delisting proceedings were announced, the closing price of our ADSs dropped from US$1.38 on June 13, 2018 to US$0.8 on June 18, 2018. The price of our ADSs has since experienced fluctuations. The trading volume and liquidity of our ADSs have also been negatively affected because, since June 18, 2018, they have been quoted on the over-the-counter markets and are not listed or traded on any national exchange. Stocks quoted on the over-the counter markets ordinarily have much lower trading volume than those listed on a national exchange, such as the NYSE or Nasdaq. Fewer market makers take interest in shares traded over-the-counter, and accordingly the markets for such shares are less orderly than is usual for NYSE-listed stocks. As a result of the low trading volumes ordinarily obtained in over-the counter markets, sales of our ADSs in any significant amount could not be absorbed without a dramatic reduction in price. Moreover, thinly traded shares in the over-the-counter markets are more susceptible to trading manipulations than is ordinarily the case for more actively traded shares.

We are evaluating whether we can find an alternative listing venue for our ADSs in the United States or for our ordinary shares elsewhere. We cannot provide assurance that we will be able to find such a listing venue. Until we are able to find an alternative listing venue, trading of our ADSs may continue the current trend, including:

 

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a limited availability of market quotations;

 

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reduced liquidity;

 

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a “penny stock” status, which will require brokers trading in our ADSs to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market;

 

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a limited amount of news and analyst coverage; and

 

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a decreased ability to issue additional securities or obtain additional financing in the future.

 

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Our ADSs are considered penny stock.

Rule 15g-9 of the Securities Exchange Act of 1934, as amended, generally defines “penny stock” to be any equity security that has a market price (as defined) less than US$5.00 per share or an exercise price of less than US$5.00 per share, subject to certain exceptions. Our ADSs are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors”. The term “accredited investor” refers generally to institutions with assets in excess of US$5,000,000 or individuals with a net worth in excess of US$1,000,000 or annual income exceeding US$200,000 or US$300,000 jointly with their spouse.

The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules.

Consequently, the penny stock rules may affect the ability of broker-dealers to trade our ADSs. We believe that the penny stock rules discourage investor interest in and limit the marketability of our ADSs.

We and certain of our directors and officers have been named as defendants in a shareholder class action lawsuit, which could have a material adverse impact on our business, financial condition, results of operation, cash flows and reputation.

We will have to defend against a shareholder class action lawsuit described in “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings,” including any appeals of such lawsuits should our initial defenses be unsuccessful. We are currently unable to estimate the possible outcome or loss or possible range of loss, if any, associated with the resolution of these lawsuits. In the event that our initial defenses of these lawsuits are unsuccessful, there can be no assurance that we will prevail in any appeal. Any adverse outcome of these cases, including any plaintiff’s appeal of a judgment in these lawsuits, could have a material adverse effect on our business, financial condition, results of operation, cash flows and reputation. In addition, there can be no assurance that our insurance carriers will cover all or part of the defense costs, or any liabilities that may arise from these matters. The litigation process may utilize a significant portion of our resources and divert management’s attention from the day-to-day operations of our company, all of which could harm our business. We also may be subject to claims for indemnification related to these matters, and we cannot predict the impact that indemnification claims may have on our business or financial results.

The market price for our ADSs has been and may continue to be volatile which could result in substantial loss to you.

The market price for our ADSs has been and may continue to be highly volatile and subject to wide fluctuations in response to factors, including the following:

 

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announcements of competitive developments;

 

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regulatory developments in the PRC affecting us, our customers or our competitors;

 

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announcements regarding litigation or administrative proceedings involving us;

 

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actual or anticipated fluctuations in our quarterly operating results;

 

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changes in financial estimates by securities research analysts;

 

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additions or departures of our executive officers;

 

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release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares or ADSs; and

 

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sales or perceived sales of additional ordinary shares or ADSs.

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. For example, since August 2008, multiple exchanges in the United States, Europe and other countries and regions, including the PRC, experienced sharp declines in response to the growing global credit market crisis and the recession in the United States and Europe. Prolonged global capital markets volatility may affect overall investor sentiment towards our ADSs, which would also negatively affect the trading prices for our ADSs.

 

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Our controlling shareholder has substantial influence over our company and its interests may not be aligned with your interests.

As of June 5, 2020, our controlling shareholder, Mr. Jianhui Lai (through Newrace Limited) beneficially owned approximately 69.5% of our outstanding ordinary shares. Mr. Lai is also our founder, chairman and chief executive officer. Please refer to Item 6E “Directors, Senior Management and Employees—Share Ownership” and Item 7B “Major Shareholders and Related Party Transactions—Related Party Transactions—Restricted Shares Granted to Mr. Yifan Li by Newrace Limited.” Our controlling shareholder has a substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. These actions may be taken even if they are opposed by our other shareholders, including those who purchased ADSs in our initial public offering. Moreover, this concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs.

The depositary for our ADSs will give us a discretionary proxy to vote our ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect your interests.

Under the deposit agreement for the ADSs, the depositary will give us a discretionary proxy to vote our ordinary shares underlying your ADSs at shareholders’ meetings if you do not vote, unless:

 

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we have failed to timely provide the depositary with our notice of meeting and related voting materials;

 

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we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

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we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting; or

 

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a matter to be voted on at the meeting would have an adverse impact on shareholders.

The effect of this discretionary proxy is that you cannot prevent our ordinary shares underlying your ADSs from being voted, absent the situations described above, and it may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

Holders of ADSs have fewer rights than shareholders and must act through the depositary to exercise their rights.

Holders of our ADSs do not have the same rights as our shareholders and may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Under our amended and restated memorandum and articles of association, as amended and restated from time to time, or memorandum and articles of association, the minimum notice period required to convene a general meeting is seven days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’ meeting to permit you to withdraw the ordinary shares underlying your ADSs to allow you to vote with respect to any specific matter. If we ask for your instructions, we will give the depositary notice of any such meeting and details concerning the matters to be voted upon at least 30 days in advance of the meeting date and the depositary will send a notice to you about the upcoming vote and will arrange to deliver our voting materials to you. The depositary and its agents, however, may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the ordinary shares underlying your ADSs. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ADSs are not voted as you request. In addition, in your capacity as an ADS holder, you will not be able to call a shareholders’ meeting.

You may not receive distributions on our ordinary shares or any value for them if such distribution is illegal or if any required government approval cannot be obtained in order to make such distribution available to you.

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities underlying our ADSs, after deducting its fees and expenses and any applicable taxes and government charges. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. For example, in March 2012, our board of directors declared a dividend to our shareholders in the amount of US$3.1 million, which has been paid to holders of ordinary shares and ADSs. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities whose offering would require registration under the Securities Act but not so properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not reasonably practicable to distribute certain property. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under the U.S. securities laws any offering of ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

 

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If we are a passive foreign investment company, you may experience adverse tax consequences.

We do not expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for the current taxable year or any future taxable year. The PFIC determination, however, depends on the application of complex U.S. federal income tax rules concerning the classification of our assets and income for this purpose, and these rules are uncertain in some respects. In addition, the market value of our assets may be determined in large part by the market price of our ADSs or ordinary shares, which is likely to fluctuate, and the composition of our company’s income and assets will be affected by how, and how quickly, we spend any cash we raise or generate. Accordingly, there can be no assurance that we will not be a PFIC for the current taxable year or in any future taxable year.

If we are treated as a PFIC for any taxable year, such characterization could result in adverse U.S. tax consequences to you if you are a U.S. investor. Please refer to Item 10E “Additional Information—Taxation—Material United States Federal Income Tax Considerations—Passive Foreign Investment Company.”

You may be subject to limitations on transfers of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deems it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

 

Item 4.

Information on the Company

A. History and Development of the Company

Our business was founded by Mr. Jianhui Lai, our chairman, chief executive officer and controlling shareholder, in 2003 under Zhengxing Wheel, a PRC company.

We, China Zenix Auto International Limited, were incorporated in the British Virgin Islands on July 11, 2008. Zhengxing Wheel became a wholly-owned subsidiary of the Company in December 2008. We completed our initial public offering, which involved the sale by us and a selling shareholder of our ADSs on May 17, 2011, with a concurrent listing of our ADSs on the New York Stock Exchange. We generated US$59.5 million in net proceeds from our initial public offering, after deducting approximately US$4.9 million for underwriting discounts and commissions, and approximately US$5.3 million for other expenses. Our ADSs were delisted from the New York Stock Exchange on December 17, 2018. An NYSE press release announcing the staff’s delisting decision cited events “contrary to the public interest and not in keeping with sound public policy, pursuant to Section 802.1D of the [NYSE’s] Listed Company Manual.” We appealed against the staff’s delisting decision but the decision was affirmed.

Our principal executive offices are located at No. 1608, North Circle Road State Highway, Zhangzhou, Fujian Province 363000, People’s Republic of China. Our telephone number at this address is (86) 596-2600308, and our fax number is (86) 596-2600558.

Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our website is www.zenixauto.com. The information contained on our website is not a part of this annual report. Our agent for service of process in the United States is Cogency Global Inc., located at 10 E. 40th Street, 10th Floor, New York, NY 10016.

The SEC maintains a web site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC using its EDGAR system.

As of December 31, 2019, our authorized share capital consisted of 500,000,000 ordinary shares of par value US$0.0001 each, of which 206,500,000 were issued and outstanding, including 62,499,988 ordinary shares represented by 15,624,997 ADSs.

B. Business Overview

Overview

We are one of the largest commercial wheel manufacturers in the PRC in both the aftermarket and OEM market in terms of sales volume, and we have maintained significant market share in recent years. We believe that our products enjoy premium brand recognition in the industry, especially among end-users. We also export our products to more than 30 countries worldwide.

 

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We design, manufacture and sell high quality steel wheels that are widely used by most types of commercial vehicles. Our product offering is one of the most diversified in the PRC commercial wheel industry. We currently offer more than 883 series of tubed steel wheels (which are typically used in commercial vehicles using tires that contain a rubber inner tube), tubeless steel wheels (which are typically used in commercial vehicles using tubeless tires), and off-road steel wheels (which are typically used in construction vehicles and other types of off-road vehicles). Each series of steel and aluminum wheels comes in a range of performance specifications, sizes and colors to meet the various requirements of our customers. We believe that our products are well recognized for safety, strength and durability by our customers, especially under extreme road conditions, and that our products exceed industry standards in all major technical aspects, including safety, durability and stability. We have won a number of awards in the PRC in recognition of, among other things, our overall business operation capabilities, brand awareness and market share. For example, we were awarded The 10th National Hundred Excellent Auto Parts Supplier Certificate in 2015 and Annual Economic Construction Contribution Award of People’s Republic of China in 2016, and were certified as Academician expert workstation in 2018. We were also recognized as The Top 100 Fujian Manufacturing Enterprise and were awarded the Certificate of the 4th Cross-Strait (Zhangzhou) Industrial Design Innovation Competition (Third Prize) and Environmental Management System Certification in 2019.

We have a diversified customer base with our products being sold in both the aftermarket and OEM market in the PRC and internationally. We sell our products to end-users in the PRC aftermarket through our nationwide distribution network, which we believe is one of the most extensive distribution networks among commercial vehicle wheel manufacturers in the PRC. In international markets, we sold our products to more than 60 distributors in the aftermarket as of December 31, 2019.

We have six manufacturing facilities across China, located in Zhangzhou, Fujian Province; Langfang, Hebei Province; Chengdu, Sichuan Province; Hefei, Anhui Province; Benxi, Liaoning Province; and Hua’an, Fujian Province. These manufacturing facilities are strategically located in close proximity to our steel suppliers, our OEM customers or ports for export, which we believe provide us with a significant advantage in production costs. Since our inception in 2003, we have established an integrated production platform covering all aspects of the design and production of a wide range of steel wheels, enabling us to quickly develop high quality products which are responsive to our customer needs, as well as to continuously improve our manufacturing process and operational efficiency.

We are committed to the research and development of new models of wheels as well as ongoing enhancements in existing product quality and production technology, in order to effectively adapt to changing demands of our customers for better quality wheel products, as well as to improve our production efficiency. We maintain our own research and development team which we believe is one of the largest in the PRC commercial wheel industry. As part of our commitment to research and development, we have amassed a large patent portfolio through internal development covering all three types of patents, namely invention, utility model and design patents.

We place great emphasis on quality control in our operations and have implemented quality control procedures throughout our production process. Our comprehensive quality management system has been awarded ISO/TS 16949 quality management system certification since 2007, which certifies the satisfaction of specific quality management system requirements for the design and development, production and, when relevant, installation and service of automotive-related products, and ISO 9001:2000 quality management system certification from 2003 to 2006, which certifies the satisfaction of specific quality management system requirements for an organization to consistently provide products that meet customer and applicable regulatory requirements. At our headquarters in Zhangzhou, Fujian Province, we have also maintained one of the national wheel test centers designated by the PRC government for the testing of the specifications and roadworthiness of wheels sold in the PRC since September 2008. This test center has been granted ISO/IEC 17025 certification, which certifies the satisfaction of the general requirements to carry out tests and/or calibrations.

Our Products

We design, manufacture and sell steel and aluminum wheels in the PRC and internationally, which are used primarily in commercial vehicles. We offer our products to end-users in the aftermarket in the PRC through our nationwide distribution network. As of December 31, 2019, such network consisted of 3,261 distributors in the PRC, including 23 tier-one distributors, 2,120 exclusive tier-two distributors and 1,118 non-exclusive tier-two distributors, throughout the PRC. We also sell our products directly to OEMs in the PRC. In addition, we sell our products outside the PRC to international distributors in the aftermarket, primarily in Thailand and more than 30 other countries worldwide.

We currently offer more than 883 series of tubed, tubeless and off-road wheels, with sizes ranging from 8 to 51 inches in diameter and 3 to 28 inches in width and which meet various specifications (including designs and colors) of our customers. In addition, we also sell our wheel components such as wheel discs to distributors for use in the aftermarket in the PRC and internationally, which accounted for an insignificant portion of our revenue in 2017, 2018 and 2019.

We believe that our broad range of products provides us with a competitive advantage over our competitors, enabling us to supply wheels for most types of commercial vehicles in the aftermarket and OEM market. Our diversified product offering also enables us to capture opportunities in the aftermarket, which is characterized by demand for a wide range of wheel types and sizes, but each in relatively small quantities, as well as to meet the various specifications required by OEMs of commercial vehicles and to adapt to changes in their requirements as they arise.

 

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We focus on developing and manufacturing wheels with enhanced safety, strength and durability while, to the extent possible, reduced weight (and thus improved fuel efficiency). We believe that our products are well recognized for safety, strength and durability by our customers, especially under extreme road conditions, and that our products exceed industry standards in all major technical aspects, including in fatigue tests to determine how long the wheel can last and pulsation tests to determine a wheel’s ability to roll smoothly on the road. In particular, we have developed a tubeless steel wheel production method that is patented and unique, whereby we can produce tubeless steel wheels which have enhanced strength and durability by applying certain manufacturing processes traditionally only used for tubed steel wheels. Wheels manufactured under this processes, in addition to improved strength and reduced weight, also exceed industry standard in terms of durability by approximately three times, according to a test conducted by the National Automobile Quality Supervision and Test Center (Xiangfan).

Tubed Steel Wheels

Tubed steel wheels are typically used with traditional tires which have a tube to seal the air inside. These traditional tires have been or are currently being gradually replaced by tubeless tires in most markets in the world (with tubeless tires being widely used in developed countries and increasingly being used in developing countries). Tubed steel wheels and traditional tires are generally stronger than tubeless steel wheels and tubeless tires, and are generally used on unpaved roadways such as rural areas, construction sites and mines under low driving speed. They are also generally used by commercial vehicles carrying heavy loads on paved roadways, such as highways and city streets. A tubed steel wheel typically consists of a wheel rim, a wheel disc and a locking ring which are assembled together. The locking ring is removable to allow tire mounting.

We currently offer more than 377 series of tubed steel wheels with sizes ranging from 15 to 24 inches in diameter and 4.5 to 14 inches in width. Tubed steel wheels generated 45.4%,46.1% and 45.1% of our revenue in 2017, 2018 and 2019, respectively.

The following shows the components of our tubed steel wheels:

 

Tubeless Steel Wheels

Tubeless steel wheels are typically used with tubeless tires. Tubeless tires are more advanced than traditional tires (which have a tube to seal the air inside) primarily in terms of safety (as the air is released slowly when the tire is punctured leading to a gentle deflation of the tire), weight and fuel efficiency. Tubeless steel wheels and tubeless tires are suited for high driving speeds and are generally used on paved roadways such as highways and city streets. A tubeless steel wheel typically consists of a wheel rim and a wheel disc which are assembled together.

We currently offer more than 342 series of tubeless steel wheels with sizes ranging from 8 to 26 inches in diameter and 3 to 20 inches in width. In particular, we have developed a type of tubeless steel wheel using a patented production technique for the design of the wheel disc. This type of wheel, other than its improved strength and reduced weight, exceeds industry standard in terms of durability by approximately three times, according to a test conducted by the National Automobile Quality Supervision and Test Center (Xiangfan). Tubeless steel wheels generated 43.9%, 41.1% and 40.8% of our revenue in 2017, 2018 and 2019, respectively.

 

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The following shows the components of our tubeless steel wheels:

 

Off-road Steel Wheels

Off-road steel wheels are used in off-road vehicles, which are typically designed for short-distance loading and off-loading purposes at locations such as construction sites and mines. Off-road steel wheels can be tubed or tubeless, typically with larger sizes and stronger or thicker materials compared to our other steel wheels. Off-road steel wheels are generally approximately five to eight times more expensive than our other steel wheels because they require the use of more raw materials and are generally produced in relatively small batches due to the specialized nature of such wheels. A majority of our off-road steel wheels are tubed.

We currently offer more than 145 series of off-road steel wheels with sizes ranging from 15 to 51 inches in diameter and 6.5 to 28 inches in width. We commenced sales of off-road steel wheels in 2008 which accounted for 1.8%, 1.6% and 2.2% of our revenue in 2017, 2018 and 2019, respectively.

The following shows the components of our tubed off-road steel wheels:

 

Aluminum Wheels

In November 2010, we established Hua’an Zhengxing Wheel Co., Ltd. as a part of our expansion to the aluminum wheel business, as the manufacturing of aluminum wheels require certain manufacturing equipment and techniques that are different from those used for steel wheels. After conducting extensive research and development for the production of aluminum wheels for use in commercial vehicles, we purchased the principal equipment and trained a number of technicians throughout 2014 and began commercial production at the third quarter of 2015. We also began production of aluminum wheels for various types of vehicles, such as high-end minibuses.

 

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We currently offer more than 19 series of tubeless aluminum wheels. For 2017, 2018 and 2019, sales of aluminum wheels accounted for 6.8%, 8.9% and 9.8% of our revenue, respectively.

Manufacturing

Manufacturing Facilities

We have six manufacturing facilities across China, located in Zhangzhou, Fujian Province (our headquarters); Langfang, Hebei Province; Chengdu, Sichuan Province; Hefei, Anhui Province, Benxi, Liaoning Province, and Hua’an, Fujian Province. Our manufacturing facilities are strategically located in close proximity to our steel suppliers, our OEM customers or ports for export. In particular, our manufacturing facilities in Langfang, Hebei Province and Benxi, Liaoning Province are located close to our steel suppliers, and our manufacturing facilities in Chengdu, Sichuan Province and Hefei, Anhui Province are located close to our OEM customers. Our manufacturing facilities in Zhangzhou, Fujian Province are located close to ports for export. These strategic locations enable us to (i) reduce our raw material and product delivery transportation costs, which is an important cost component of both our raw materials and steel wheels, (ii) respond to changes in customer demand quickly and (iii) access a sufficient supply of skilled local labor force at relatively low cost compared to the labor cost at major urban centers in the PRC.

We have undergone a series of expansions to our existing manufacturing facilities. Our production volume for aluminum wheels reached 700 sets and 800 sets per day by the end of 2017 and 2018, respectively. The production volume for aluminum wheels remained at 800 sets per day in 2019.

The following shows the geographic locations of our manufacturing facilities, with floor area and number of employees as of December 31, 2019:

 

 

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Production Capacity

We believe that we have one of the largest production capacity among commercial wheel manufacturers in the PRC. As of December 31, 2019, our manufacturing facilities had a designed annual production capacity of approximately 15.5 million units of steel and aluminum wheels, of which 9.5 million units were tubed steel wheels, 5.5 million units were tubeless steel wheels, 33,600 units were off-road steel wheels and 0.5 million units were aluminum wheels. The size of our manufacturing platform allows us to achieve significant economies of scale as we increase our production volume. With our large scale, we are also able to lower our costs by preparing various wheel components internally.

Production Process

Components and Raw Materials

The two principal parts of our steel wheels are a wheel rim, onto which the tire is attached, and a wheel disc which fits into the center of the wheel rim. In addition, our tubed steel wheels use one or more removable metal locking rings attached to the outside edge of a wheel rim so that a tire with inner tube can be mounted. Locking rings are typically assembled to the wheels by our distributors or OEM customers.

Our principal raw materials are steel, as well as other auxiliary materials including welding material, paint and powder coating. We use different types of steel for tubed and tubeless steel wheels. We typically use rim-shaped steel (which we make ourselves using raw steel purchased from our suppliers) for tubed steel wheels and rolled steel plates (i.e., steel which is shaped into plates and rolled in a spool under high heat by the steel manufacturer) for tubeless steel wheels. We have also introduced tubeless steel wheels using rim-shaped steel internally produced by applying our unique patented tubeless steel wheel production method, which provides enhanced strength and durability. Our work-in-progress primarily includes wheel rims, wheel discs and locking rings.

 

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We source our principal raw materials and a majority of locking rings from third-party suppliers and manufacture the remaining wheel components, including rim-shaped steel, wheel rims, wheel discs and the remaining portion of locking rings, internally. We believe that self-producing most of our steel wheel components, in particular rim-shaped steel, enables us to reduce our production costs and production time, ensure timely delivery to meet customers’ orders, and also ensure high product quality. In addition, as one of the largest commercial wheel manufacturers in the PRC, we have been able to maintain more than ten years of relationship with our second largest steel supplier, Benxi Iron & Steel, and our largest steel supplier, Shougang Jingtang Iron & Steel Co., Ltd, from whom we source steel that meets our specific requirements. This allows us to optimize our production process and increase our raw material utilization rate.

Steps

Our manufacturing process primarily involves the following steps:

 

 

 

(1)	This step differs for tubed steel wheels and tubeless steel wheels as explained below.

Each of the foregoing manufacturing steps is described below:

Wheel Rims

Preparation of raw materials: For our tubed steel wheels, we press and roll under high heat raw steel sourced from our steel suppliers to form rim-shaped steel, which is then cut into rectangular slices and used in the production of wheel rims.

 

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For our tubeless steel wheels, we flatten rolled steel plates sourced from our steel suppliers and cut it into rectangular slices (with the edges refined), which is then used in the production of wheel rims. We have also introduced tubeless steel wheels using rim-shaped steel internally produced by applying our unique patented tubeless steel wheel production method, which provides enhanced strength and durability. Please refer to “—Research and Development” below.

Rounding and welding: The rectangular steel slice is rounded to produce a cylindrical sleeve with the two free edges of the sleeve welded together.

Refining: Surface and welded edges of the sleeve are refined and smoothed.

Shaping: For our tubed steel wheels, the sleeve is expanded and compressed into the required circular shape and becomes a wheel rim.

For our tubeless steel wheels, the sleeve is expanded and rolled (as opposed to being compressed, in order to enhance and improve the safety and weight of the wheel rim) into the required circular shape and becomes a wheel rim.

Inspection and testing: The wheel rim is inspected for sizes and undergoes pulsation tests to determine the wheel’s ability to roll smoothly on the road.

Wheel Discs

Preparation of raw materials: We flatten rolled steel plates sourced from our steel suppliers and stamp the steel to produce multiple rounded plates.

Punching holes: The rounded plate is punched for holes.

Spinning and pressing: The rounded plate is spun and pressed into geometric shape.

Punching additional holes: Additional holes are punched into the edge of the geometric-shaped plate.

Refining: Geometric shape of the plate is refined and the plate becomes a wheel disc.

Inspection and testing: The wheel disc is inspected for its shape and undergoes pulsation tests.

Wheel Assembly

Welding: The wheel rim and the wheel disc are welded together to become a wheel.

Testing: The assembled wheel undergoes pulsation and balancing tests.

Coating: The assembled wheel is coated through pre-treatment and painting or powder coating.

Packaging: Wheels are packaged using cartons, wooden pallets or packaging foil based on customers’ requirements.

Design and Production

We conduct each of the above steps in-house. When we commence production of new products, we design and manufacture different molds, based on different customers’ requirements and market needs, which are then used in the production process. Using specialized computer software that enables us to create three-dimensional designs, our highly experienced research and development team can efficiently develop new molds for most types of commercial wheels. With our industry-leading production scale in the PRC and integrated production process, we are able to manufacture a wide variety of molds and quickly commence commercial production of multiple new wheel models at the same time, which distinguishes us from our competitors. Our integrated production process also increases our production efficiency and reduces our dependence on third-party suppliers. Our design expertise, large production scale and integrated production process enable us to adjust our production quickly to respond to changes in market demand for our products. It generally takes us less than one week to produce our existing products after we receive purchase orders.

We maintain separate production lines for our tubed, tubeless and off-road steel wheels. The production of different wheels primarily involves similar processes as described above but different machinery and equipment, molds and techniques. Our production process satisfies ISO/TS 16949 quality management requirements.

 

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Electricity is the primary utility used in our manufacturing process. We receive our electricity supply from local power grids where our plants are located. To date, we have not experienced any material disruption in electricity and other utilities. We sell scrap steel from our manufacturing process to third parties or recycling stations.

Techniques and Machinery

We apply various advanced techniques in our production process, which reduce our production costs and make our wheels superior in terms of strength, durability and/or weight in comparison to the wheels offered by our competitors in the PRC. For example, in the manufacturing of wheel discs, we use a refined and more cost-effective steel cutting technique when stamping the steel. This technique enables us to maximize the number of rounded plates we can stamp from a steel plate, thereby increasing our raw material utilization rate and reducing the amount of scrap steel and in turn our production costs. We also use a spinning and pressing technique when making the plates into a geometric shape. By spinning and pressing the wheel disc instead of simply pressing it into the desired shape, which is the traditional method employed, we can reduce the weight of the wheel disc and amount of steel used without lessening the strength and durability of the wheel disc.

We use various advanced machinery and equipment in our production process, substantially all of which is sourced from PRC machinery and equipment manufacturers. We also imported from Germany an advanced spinning and pressing machine used in the manufacturing of our wheel discs. We are in the process of enhancing the automation of our manufacturing process, which will enable us to increase production efficiency and reduce production costs. Our principal manufacturing machinery and equipment is not difficult to obtain. We have implemented a comprehensive maintenance system for our machinery and equipment. To date, we have not experienced any material or prolonged interruptions of our machinery or equipment due to its failure.

Aluminum Wheel Manufacturing Facility in the PRC

We anticipate that commercial vehicles will increasingly use wheels made of aluminum instead of steel in the future and commenced our commercial production of aluminum wheels in the third quarter of 2015. Our aluminum wheels are manufactured at an advanced aluminum wheel manufacturing facility (including offices, a research and development center, a test center and employee dormitories) with an aggregate land area of approximately 65,000 square meters in Zhangzhou, Fujian Province. Construction of the facility was completed in September 2015, with the first production line reaching maximum capacity utilization as of the end of 2017. We started investing in our second production line in 2017, which commenced partial production in the fourth quarter of 2017. We have obtained land use rights and property ownership certificates for this manufacturing facility. We have obtained substantially all of the necessary machinery and equipment and are in the process of upgrading a specialized production process designed for manufacturing aluminum wheels for commercial vehicles, conducting research and development, procuring raw materials and recruiting additional industry experts in order to ramp up our aluminum wheel production. We believe we are well positioned to enter the aluminum wheel market, and by developing different types of high quality aluminum wheels and being an early market entrant, we believe that we will be well positioned to capture future growth in the market for aluminum wheels in the PRC as it emerges and also to enter selected international markets over time.

Sales and Marketing

We have a diversified customer base. We offer our products to end-users in the aftermarket in the PRC through our nationwide distribution network. As of December 31, 2019, such network consisted of more than 3,261 distributors, including 23 tier-one distributors, 2,120 exclusive tier-two distributors and 1,118 non-exclusive tier-two distributors, throughout the PRC. We also sell our products directly to OEMs in the PRC. PRC aftermarket sales accounted for 32.1%, 31.8% and 36.3% of our revenue in 2017, 2018 and 2019, respectively. PRC OEM sales accounted for 54.2%, 55.8% and 52.2% of our revenue in 2017, 2018 and 2019, respectively.

In addition, we sell our products outside the PRC to international distributors in the aftermarket, primarily in Thailand, Vietnam and more than 30 other countries worldwide. International sales accounted for 13.7%, 12.4% and 11.5% of our revenue in 2017, 2018 and 2019, respectively. In 2017, 2018 and 2019, the aggregate sales to our five largest customers accounted for 24.6%, 26.5% and 24.8% of our revenue, respectively.

We have a dedicated sales and marketing team, which had 235, 235 and 233 employees as of December 31, 2017, 2018 and 2019, respectively. The team is responsible for the sales and marketing of our products and managing and supporting our distributors. We believe that the combination of our extensive distribution network and our effective management of such network provides us with the broadest coverage among PRC commercial wheel manufacturers, which has contributed to our leadership position in the PRC aftermarket and presents a significant barrier to entry in that market.

 

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Domestic Sales

Aftermarket Sales

Our products are sold to end-users in the aftermarket in the PRC as replacements for worn out or lower quality wheels through our nationwide distribution network, which covers all provinces, autonomous regions and municipalities in the PRC and includes various distributors, retail stores and repair and maintenance shops. In addition to selling our products, these distributors typically also sell other automotive components. End users in the aftermarket typically focus on wheel manufacturers’ product quality, value for money, brand reputation, technology and ability to develop new products, delivery timeliness, after-sales service and customer relationships.

We believe that our extensive distribution network provides us with a distinct competitive advantage over our competitors because it enables us to: (i) reach end-users across China in a cost-effective manner, thereby increasing our penetration of the fragmented PRC aftermarket, (ii) closely monitor market trends and end-user preferences, enabling us to swiftly meet end-user demands and (iii) lower our logistics costs as we can get our products to end-users quickly and efficiently through our distributors.

Our PRC aftermarket sales involves the sale of our products to tier-one distributors, which carry our products on an exclusive basis and have direct contractual relationships with us. These tier-one distributors resells our products to tier-two distributors. Tier-two distributors are divided into exclusive and non-exclusive distributors, depending on whether they only sell steel wheels manufactured by us. The number of our tier-two distributors decreased from 2014 to 2019 primarily as a result of the economic slowdown. The following table sets forth the total number of our tier-one, exclusive tier-two and non-exclusive tier-two distributors in the PRC as of December 31, 2017, 2018 and 2019, respectively:

 

		As of December 31,
		2017				2018				2019
Tier-one			23				23				23
Exclusive tier-two			2,308				2,231				2,120
Non-exclusive tier-two			1,216				1,128				1,118
Total			3,547				3,382				3,261

We generally select our tier-one distributors based on business reputation, size, industry and sales experience, quality of the management team, and prior sales performance, and enter into annual distribution agreements with our tier-one distributors which are renewed automatically every year unless terminated by the parties. Pursuant to our contractual arrangements, (i) our tier-one distributors may not distribute any other commercial wheel manufacturer’s products, (ii) our tier-one distributors generally cover particular regions and may not distribute our products outside their respective regions, (iii) we set sales targets for our tier-one distributors and generally provide sales incentives or raise credit limits if the sales targets are met or exceeded by our tier-one distributors, (iv) our tier-one distributors are required to provide us a credit deposit typically equal to approximately one-month of indicative annual purchase amount, and depending on the actual sales amount, we typically provide our tier-one distributors a credit term of 45 to 55 days from the receipt of our invoice after product delivery and (v) our tier-one distributors are typically required to comply with all applicable laws and regulations in distributing our products. We conduct annual evaluations of our tier-one distributors.

We enter into a three-party distribution agreement with each exclusive tier-two distributor and the tier-one distributor covering the particular locale in which the exclusive tier-two distributor is located for a one-year term which is renewed automatically every year unless terminated by the parties. These agreements enable us to directly interact with and monitor our exclusive tier-two distributors while at the same time maximize our efficiency by delegating certain management oversight of our tier-two distributors to the relevant tier-one distributors. Pursuant to our contractual agreements, (i) our exclusive tier-two distributors may not distribute any other commercial wheel manufacturer’s products, (ii) our exclusive tier-two distributors generally cover particular regions and may not distribute our products outside their respective regions, (iii) tier-one distributors set sales targets for our exclusive tier-two distributors and generally provide sales incentives or raise credit limits if the sales targets are met or exceeded by our exclusive tier-two distributors and (iv) our exclusive tier-two distributors are typically required to comply with all applicable laws and regulations in distributing our products. In order to better enhance our brand recognition, exclusive tier-two distributors display signage and posters bearing our “Zhengxing” brand name and logo and follow decoration and product display standards based on our requirements, with the relevant expenses paid by us. We and our tier-one distributors conduct annual evaluations of our exclusive tier-two distributors.

Although we do not have contractual agreements with our non-exclusive tier-two distributors, we require our tier-one distributors to enforce our sales and return policies, guidelines and procedures on the non-exclusive tier-two distributors. Non-exclusive tier-two distributors can distribute other commercial wheel manufacturer’s products, although in practice, certain of our tier-two distributors voluntarily sell our products on an exclusive basis. Any non-compliance with our guidelines by non-exclusive tier-two distributors will be the responsibility of the relevant tier-one distributors.

 

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Our sales and marketing team monitors, manages and supports the activities of our tier-one distributors and exclusive tier-two distributors to ensure that they comply with our sales guidelines, policies and procedures, and contractual arrangements. Our sales and marketing team regularly visits and inspects distributors, including their inventory levels, and assists and resolves any problems encountered by them. In addition, we provide periodic training to our tier-one distributors and principal exclusive tier-two distributors to impart product-related knowledge and information as well as to improve their sales and marketing skills.

OEM Sales

We also sell our products directly to OEMs in the PRC for use in their commercial vehicles. We had 80 OEM customers, 81 OEM customers, and 77 OEM customers as of December 31, 2017, 2018 and 2019, respectively. The number of our OEM customers in the PRC has remained steady, although we experienced slight decrease in this type of customers during 2019 due to economic slowdown. Our OEM customers include the group members of a number of large PRC commercial vehicle manufacturers such as SAIC-IVECO Hongyan Commercial Vehicle, BeiqiFoton Motor, Zhengzhou Yutong, FAW Jiefang Automotive, Anhui Jianghuai Automobile Group and China National Heavy Duty Truck Group. When selecting wheel suppliers, OEM customers typically look at factors such as price, product quality (and typically require suppliers to provide product test reports issued by a recognized test center), technology and ability to develop new products that meet their specifications, production scale, delivery timeliness, after-sales service and customer relationships.

Our existing OEM customers typically give us their product specifications and ask us to provide samples. When developing new vehicle models, our OEM customers will usually notify us of their plans and ask us to develop new wheel designs to meet their new requirements. Our sales and marketing team also provides samples of our products to existing OEM customers when we develop new wheel models. After we receive confirmation from the OEM customers that the samples of our products are acceptable to them, we will produce a small amount of the product for test use. Upon satisfactory completion of the test use, we typically enter into framework agreements with our OEM customers, which are renewed every year upon mutual agreement unless terminated by the parties, and commence mass production. This process typically takes about six months. In addition, our sales and marketing team proactively contacts and visits new OEMs to introduce our products to them and to develop new customer relationships. On occasion OEMs who are not our customers will initiate contact by requesting product samples from us.

Our framework agreements with OEM customers generally set a price, which is subject to periodic revision based on the market price of steel. OEM customers, pursuant to the framework agreements, then periodically place orders which specify the amount of purchases desired. The framework agreements do not contain minimum purchase requirements. Depending on the sales amount, we typically provide our OEM customers in the PRC a credit term of 90 days from the receipt of our invoice after product delivery.

We have long-term business relationships with most of our OEM customers, and to date, we have not had any material disputes with our OEM customers. We have been strengthening, and will continue to strengthen, our relationships with leading commercial vehicle OEMs. We seek to become their preferred wheel supplier by, among other things, utilizing our nationwide distribution network to provide aftermarket sales service and support to end-users for OEM customers across the PRC. We believe this will benefit OEMs because end-users generally prefer commercial vehicles that can be easily serviced at a variety of locations. Further, this will lead to high brand awareness of our products among end-users in the aftermarket, resulting in some end-users requesting that our wheels be used on the OEMs’ vehicles at the time of purchase.

We have been enhancing, and will continue to enhance, our research and development capabilities in order to continue to develop products meeting the specific requirements and changing needs of our PRC OEM customers. Furthermore, we will continue to leverage the strategic locations of our nationwide manufacturing facilities to further improve our ability to promptly meet the demands of our PRC OEM customers. We believe that maintaining strong relationships with multiple OEMs will enable us to acquire additional market share in the PRC OEM market and fully benefit from the ongoing trend of OEMs increasingly outsourcing the production of commercial wheels.

 

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International Sales

Our international sales include primarily sales to international distributors, which resell our products to OEMs and retail stores, repair and maintenance shops or end-users in the aftermarket. In addition to selling our products, these distributors, retail stores and repair and maintenance shops also typically sell other automotive components. We had 66, 87 and 87 international distributors as of December 31, 2017, 2018 and 2019, and the top five distributors in 2019 included Li Li Ai of Burma, AUTO JAYA of Indonesia, Oliver of the Philippines, UNIVERSAL AUTO ENGG. of Pakistan and Well Product Trading LP of Thailand.

We export our products to more than 30 countries worldwide, including Thailand, Vietnam, Malaysia, Pakistan and Indonesia. Vietnam was our largest international market in 2017, representing 1.4% of our revenue in 2017. Thailand was our largest international market in 2018 and 2019, representing 1.3% and 1.2% of our revenue in 2018 and 2019, respectively. We have been increasing our sales and marketing efforts in select countries in Asia and the Middle East which we believe present attractive market opportunities. In North America and Europe, we focus on partnering with local distributors to increase our sales in the aftermarket as well as to OEMs to establish our brand name in those markets.

We typically procure sales to international distributors and OEMs through participation in various exhibitions, trade shows and seminars for the automotive industry. The selection criteria for international distributors are similar to those for domestic distributors. We enter into strategic cooperation agreements with our ten largest international customers (including distributors and OEMs) which are renewed every three years upon mutual agreement unless terminated by the parties, pursuant to which such customers place orders from time to time that specify the actual price and amount of purchases. These strategic cooperation agreements provide that we are the preferred wheel supplier of these international distributor or OEM customers. We do not have strategic cooperation agreements with our other international distributor or OEM customers, who place orders with us from time to time pursuant to standalone purchase orders. We typically provide our international distributor and OEM customers a credit term of 30 days from the receipt of our invoice after product delivery. For certain new international customers, we require payment of the entire purchase price at the time of purchase. Our sales and marketing team periodically visits our international distributors to ensure that they comply with our sales guidelines, policies and procedures and to provide relevant support.

Product Delivery

We generally deliver our products to tier-one distributors and OEM customers in the PRC by truck or by train. We pay the cost of transporting our products to our customers and include such transportation cost in the prices of our products. We make international deliveries primarily by sea. Our export contracts are usually entered into on a Free On Board (FOB) basis, which means that we pay for shipping of the goods to the port of shipment, plus loading costs. Our customers pay freight, insurance, unloading costs and shipping from the port of destination to the factory.

We outsource the delivery of our products to reputable transportation service providers, and on behalf of our international customers, we engage a number of shipping agents to transport our finished products overseas. Our strategically located manufacturing facilities in different regions of China enable us to lower product delivery transportation costs, reduce transit time and satisfy the needs of our customers promptly, which distinguish us from our competitors. To date, we have not experienced any material backlogs or delays in meeting customer orders.

Pricing

We price of our products on the basis of market supply and demand and adjust such prices from time to time based on the prices of our raw materials, particularly steel. Because of our leading market position and the strong demand for our products, we believe we generally are able to set the prices of our products at a premium and pass on any significant increases in our raw material costs to our customers. Also, as wheels generally extend the useful lives of tires, which are usually more expensive than wheels, we believe that wheels are typically less subject to downward price pressure by end-users and end-users are usually willing to pay higher prices for high-quality wheels, like ours, thus strengthening our ability to set the prices of our products. In addition, we generally reduce the selling prices of our products when there are significant decreases in our raw material costs.

Warranty

In line with market practice, we do not provide exchanges or returns of our products. For our products sold to OEMs in the PRC, we allow them to deduct an amount (typically equal to or less than 1.0% of the total invoice amount) from the invoice amount we charge which can be used to cover any defective products. For our PRC aftermarket sales, our tier-two distributors typically provide end-users with product exchanges or returns for defective products within a three-month warranty period. Upon an exchange or acceptance of a return of a defective product, two-tier distributors will either exchange the defective product with, or return the defective product to, their tier-one distributors, or deduct an amount from the invoice payable to their tier-one distributors, depending on their arrangements with the particular tier-one distributors.

 

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We also do not provide any warranty for our products sold to international customers, and we do not provide exchanges or returns of our products for these customers.

Marketing

Our sales and marketing team markets and promotes our brands and products. In the PRC, most of our products are sold under our “Zhengxing” and “Zhengxing Prince” brands, which we use for our more advanced wheels with higher specifications in terms of strength, durability, weight and other factors. We also sell less complex, lower cost products under our “Haixia,” “Zhengchang,” and “Lianxing” brands. In the international markets, most of our products are sold under our “CZX” brand.

In the PRC, our sales and marketing team regularly visits our distributors to better understand the needs and requirements of the end-users and any new market trends. We also regularly visit OEM customers to better understand their operations, needs and requirements and to introduce our new products. In addition, we participate in various exhibitions, trade shows and seminars for the automotive industry to promote and market our products to new customers. Our marketing efforts include advertising on billboards and in automotive magazines and distributing product brochures and product-related gifts such as T-shirts, posters and calendars to our customers and end-users. Generally, we are responsible for our marketing costs, and our distributors typically cooperate with us in conducting our marketing and promotional activities.

In the international markets, our marketing efforts primarily consist of periodic visits to our distributors and OEM customers and participation in various exhibitions, trade shows and seminars for the automotive industry.

In addition, we maintain a customer service hotline for our customers and end-users to respond to their inquiries and feedback on our products.

Research and Development

We are committed to the research and development of new models of wheels as well as ongoing enhancements in existing product quality and production technology, in order to effectively adapt to changing demands of our customers for better quality wheel products, as well as to improve our production efficiency. We have established strong research and development capabilities which are important competitive factors in the commercial wheel industry, particularly for OEM customers who prefer to work with vehicle wheel manufacturers that can quickly develop safe, strong, durable and/or light-weight wheels meeting their specifications.

We believe that we maintain one of the largest skilled teams of research and development engineers and technicians in the commercial wheel industry in the PRC. As of December 31, 2017, 2018 and 2019, our research and development department had 194, 195 and 193 employees, respectively, most having 10 to 20 years of experience in the industry. In recent years, we gradually streamlined our research and development focus. We are now focusing on the research and development of light-weight steel wheel and aluminum wheel products while conducting less research and development on traditional steel wheel products.

We conduct substantially all of our research and development efforts internally and also collaborate with leading industry experts in the PRC and internationally. Our research and development efforts currently focus on the development of new models of steel wheels, and we have developed and commercialized approximately 30, 26 and 46 new models of steel wheels in 2017, 2018 and 2019, respectively. We also focus on making ongoing enhancements in existing product quality and production technology so as to improve, among other things, the safety, strength and balance, and reduce the weight (and thus improve fuel efficiency), of our products, and reduce the overall cost of our production process, as well as to further automate our manufacturing process. For example, we have developed a tubeless steel wheel production method that is patented and unique, whereby we can produce tubeless steel wheels which have enhanced strength and durability by applying certain manufacturing processes traditionally only used for tubed steel wheels. Under this patented method, we use rim-shaped steel (which we make from raw steel by pressing and rolling it under high heat), instead of rolled steel plate, as the raw material, and we apply compression, instead of rolling, at the stage of shaping. Please also refer to “—Production Process” above. We first commercialized tubeless steel wheels using this innovative production method in 2008. We are also in the process of using this patented method to develop light-weight tubeless steel wheels. Moreover, we have developed a new type of energy-saving and environmentally friendly “Tulou Steel Wheel” wheel and aluminum wheel for various types of vehicles such as high-end minibuses. In addition, we continue our research and development of commercial wheels made of aluminum, a new product line which we launched in 2015.

Our research and development team works closely with our sales and marketing team which collects requests regarding new wheel products and feedback on product quality and improvements from our distributors and OEM customers. We intend to continue further enhancing our existing research and development efforts.

We maintain a well-equipped research and development center at our headquarters in Zhangzhou, Fujian Province and at our manufacturing facilities in Langfang, Hebei Province and Hefei, Anhui Province, and perform all of our research and development activities in-house. In addition, we utilize advanced techniques in our product research and development, such as specialized computer software that enables us to create three-dimensional designs for the development of new types of wheels.

 

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Furthermore, at our headquarters in Zhangzhou, Fujian Province, we have maintained one of the national wheel test centers designated by the PRC government for the testing of the specifications and roadworthiness of wheels sold in the PRC since September 2008. This test center has been granted ISO/IEC 17025 certification. It enables us to quickly test our new products onsite, thereby shortening our product development cycle to less than 30 days, which we believe is significantly less than that of our competitors. This test center also assists our penetration of the OEM market because OEMs typically require test certifications demonstrating that the wheels they use meet or exceed industry standards.

Intellectual Property

We own a large portfolio of intellectual property rights in the PRC to protect the technologies, inventions and improvements significant to our business, and we believe that this is important in order for us to maintain a competitive advantage in the marketplace.

As part of our commitment to research and development, we have amassed a large patent portfolio through internal development covering all three types of patents, namely invention, utility model and design patents. As of December 31, 2019, we owned a total of 110 patents in the PRC, including 5 invention patents, 97 utility model patents and 8 design patents. The benefits of our patented technology include, among other things, improving the performance of our wheels and increasing the utilization of raw materials. In addition, as of December 31, 2019, we had registered 656 trademarks with China’s Trademark Office, and are currently in the process of applying for 8 additional trademarks in the PRC. Through the Madrid System for the International Registration of Marks, we have registered two trademarks each with one jurisdiction in the United States and South Korea, respectively. We also have two registered trademarks in Taiwan. These trademarks are primarily related to the name and logo of our company. In 2005, “Zhengxing” was recognized as a “PRC Famous Trademark”.

We rely primarily on intellectual property laws and contractual arrangements with our employees and others to protect our intellectual property rights. We have entered into agreements with most of our executive officers and employees involved in technology and research and development, under which intellectual property during their employment belongs to us, and they waive all relevant rights or claims to such intellectual property. Generally, our executive officers and employees involved in technology and research and development are also bound by a confidentiality obligation, and have agreed to disclose and assign to us inventions conceived by them during their term of employment. While we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of our intellectual property. The counterparties to our confidentiality agreements may not follow such agreements, or our confidentiality agreements may not be enforceable or provide an adequate remedy in the event of an unauthorized use or disclosure. Infringement or misappropriation of our intellectual property could harm our business and competitive position.

Our competitors are also developing and seeking patent protection for technologies in connection with the manufacturing of wheels. We expect these competitors to continue to take steps to protect these technologies, including seeking patent protection. There may be patents issued or pending held by others that cover significant parts of our technology or business methods. Disputes over rights to these technologies may arise in the future. We cannot be certain that our products do not or will not infringe valid patents or other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others.

To date, we have not been a party to any material intellectual property claim. We are not aware of any proceedings concerning, and are not aware of any material claims or infringements of, any intellectual property rights that may be threatened or pending, in which we may be involved whether as a claimant or respondent.

Quality Control and Assurance

We place great emphasis on quality control in our operations and have implemented quality control procedures throughout our production process to ensure consistent product quality that meets our quality control standards and policies. Our products are also subject to customized quality requirements of our customers. Our quality control department works closely with our technology and manufacturing departments to carry out our quality control procedures. Our senior management team is also actively involved in setting our quality control policies.

We have established a comprehensive quality management system from procurement to delivery in accordance with ISO/TS 16949 quality management requirements for our operations. Our comprehensive quality management system has been awarded ISO/TS 16949 quality management system certification since 2007, which certifies the satisfaction of specific quality management system requirements for the design and development, production and, when relevant, installation and service of automotive-related products, and ISO 9001:2000 quality management system certification from 2003 to 2006, which certifies the satisfaction of specific quality management system requirements for an organization to consistently provide products that meet customer and applicable regulatory requirements. In addition, as describe above under “—Research and Development,” at our headquarters in Zhangzhou, Fujian Province, we have maintained one of the national wheel test centers designated by the PRC government for the testing of the specifications and roadworthiness of wheels sold in the PRC since September 2008. This test center has been granted ISO/IEC 17025 certification, which certifies the satisfaction of the general requirements to carry out tests and/or calibrations. We source substantially all of our principal test equipment from PRC suppliers. In addition, representatives of our tier-one distributors, OEM customers and international distributors and OEMs periodically inspect our manufacturing facilities and quality management system.

 

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Our quality control procedures primarily consist of the following:

 

•

Raw material inspection: We purchase our principal raw materials from selected reputable suppliers (generally in terms of product quality, prices, production capabilities and management) and conduct periodic evaluations of our principal suppliers. All raw materials delivered by suppliers to us are inspected before acceptance to ensure that they comply with our raw material standards.

 

•

Process control: We have implemented various quality control measures (including conducting various tests such as pulsation and balance tests and inspections of sizes) in each of the key stages of our production process.

 

•

Product inspection: We examine our finished products for defects.

 

•

Periodic functionality tests: Based on the requirements of our customers, we conduct periodic functionality tests of our products, including radial fatigue tests, bending fatigue tests, welding strength tests and material inspection.

In addition, in conjunction with the expansion of our production capacity, we improve our production efficiency and operational effectiveness by, among other things, implementing advanced management systems designed to improve performance, such as lean manufacturing techniques and six-sigma quality control processes. We have commenced training for our employees of six-sigma quality control processes and are gradually implementing such processes to our business operations.

Suppliers and Procurement

As one of the largest commercial wheel manufacturers in the PRC, we have developed strong relationships with our suppliers and are generally able to obtain our key raw materials and supplies at competitive prices. We source almost all of our raw materials from suppliers in the PRC.

Our principal raw material is steel (including raw steel which we make into rim-shaped steel and rolled steel plates), which accounts for substantially all of our total raw material requirements. We purchase steel from a limited number of selected reputable suppliers in the PRC. We generally enter into framework agreements with our steel suppliers, pursuant to which we place orders from time to time and have a one-year term, renewable every year upon mutual agreement. These agreements typically set a total purchase amount. The actual purchase price and amount of steel vary from order to order. Prices of steel are subject to fluctuation depending on supply and demand in the market, and we are generally able to purchase steel at prices slightly lower than the prevailing market prices because of our large volume of purchases. In addition, we purchase steel which meets our specific requirements from our primary steel supplier, Shougang Jingtang Company, allowing us to optimize our production process and increase our raw material utilization rate. Unlike our Company, certain of our competitors in the PRC, which operate on a relatively smaller scale, often may need to buy steel with standard specifications indirectly through distributors, which may increase their costs and decrease their raw material utilization rate.

Our other raw materials include welding material, paint and powder coating, and we purchase such auxiliary materials from multiple suppliers which are easily replaceable. In addition, we also purchase a majority of our locking rings used in the production of tubed steel wheels from a limited number of suppliers. We do not have annual framework agreements with suppliers of our auxiliary materials and locking rings and generally place orders for these materials from time to time.

In line with market practice, we typically make full prepayment at the time of purchase to the suppliers of our steel. Our suppliers of other auxiliary materials including welding material, paint and powder coating and our suppliers of locking rings typically provide us a credit term of 30 to 35 days and a credit term of 50 to 60 days, respectively. We have long-term business relationships with most of our principal suppliers. For example, we have a more than ten-year relationship with Benxi Iron & Steel, our primary steel supplier. To date, we have not had any material disputes with our suppliers. We manage our inventory levels by monitoring in real time our production activities and incoming sales orders and also taking into consideration market prices of the raw materials, particularly steel. Based on this, we assess our requirements for raw materials and locking rings, and place orders with suppliers accordingly. We typically maintain approximately one to two months’ supply of steel, approximately one month’s supply of other auxiliary materials and less than one month’s supply of locking rings.

 

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We have been dependent on a limited number of suppliers for a significant portion of our raw material and locking ring requirements. In 2017, 2018 and 2019, the aggregate purchases from our five largest suppliers accounted for 80.8%, 82.6% and 80.5% of our total raw material and locking ring costs, respectively. Purchases from one of our largest suppliers, Shougang Jingtang Iron & Steel Co., Ltd., for the same periods accounted for 36.5%, 33.8% and 33.0% of our total raw material and locking ring costs, respectively. Purchases from another one of our largest suppliers, Benxi Iron & Steel, for the same periods, accounted for 21.8%, 22.0% and 20.1% of our total raw material and locking ring costs, respectively. Although there are alternate steel suppliers in the market, because we have optimized our manufacturing process to rely on the steel of our established key suppliers (especially Shougang Jingtang Iron & Steel Co. and Benxi Iron & Steel), which meet certain specifications, any disruption in steel from those suppliers may disrupt our manufacturing operations until we can secure appropriate steel from other suppliers. We believe that we will continue to purchase a significant portion of our raw materials and locking rings from a limited number of suppliers.

Competition

The market for commercial wheels, especially the OEM market, is characterized by intense competition among multiple vehicle wheel manufacturers, with competition based on a number of factors. The key competitive factors in the aftermarket are product quality, product diversification, brand reputation, technology and ability to develop new products, delivery timeliness, after-sales service and customer relationships. In the OEM market, the same factors apply, except that OEMs are relatively more concerned with production scale rather than product diversification or brand reputation. We believe that our competitive advantages include economies of scale, high product quality and brand recognition, comprehensive product offerings, strong research and development abilities, nationwide strategic locations of our manufacturing facilities and nationwide coverage of our distribution network, which have enabled us to achieve our leadership position in the commercial wheel market in the PRC and to establish a strong presence internationally.

In the PRC market, we primarily compete with companies such as Shandong Xingmin Wheel, Dongfeng Motor Wheel, Changchun FAWAY Automobile Components, Xiamen Sunrise Wheel and Alcoa Inc. In the international market, we primarily compete with various local wheel manufacturers at each of our sales region. In addition, there is increasing consolidation within the commercial wheel industry in the PRC. We believe that with our leadership position in the commercial wheel industry in the PRC, we are well positioned to lead or participate in this industry consolidation which may further strengthen our leading market position. Nevertheless, if we fail to maintain or increase our market share, this consolidation in our industry could cause our competitors to develop advantages over us in their available capital, per-unit cost in manufacturing operations, purchasing power with suppliers, pricing power with customers, scale of distribution network, brand recognition and other factors that could adversely affect our business, financial condition, results of operations and prospects.

Other types of commercial wheels, such as aluminum wheels, also compete with our products. We began offering our own aluminum wheels at the end of 2013, but we have limited experience in the production and sales of such wheels on a commercial scale. Since we began commercial production of aluminum wheels in the third quarter of 2015, the market acceptance of aluminum wheel product continuously increased, aluminum wheel sales accounted for 9.8% of revenue of 2019 compared with 8.9% in 2018.

Environmental Matters and Safety

Our production process primarily generates and discharges waste water, waste gas, noise and solid waste. We have adopted various policies and implemented various measures to treat and process such waste and to ensure our compliance with applicable environmental laws and regulations. We sell certain of our solid waste such as scrap steel to third parties or recycling stations.

We are required to comply with applicable PRC national and local environmental protection laws and regulations, and our operations are subject to periodic inspection by national and local environmental protection authorities. PRC national and local environmental laws and regulations impose fees for any discharge of waste materials above prescribed levels and fines for any serious violation, and provide that the relevant authorities may at their own discretion shut down or suspend the operation of any facility that fails to comply with orders requiring it to cease or remedy operations causing environmental damage. To date, we have not been subject to any material fines, suspension orders or other administrative actions from the PRC environmental authorities, and we believe that we are currently in compliance with all applicable environmental regulations and standards in all material respects. We are not aware of any pending or threatened environmental investigation, proceedings or action by any governmental agency or other third party.

We have adopted various policies and implemented various measures to ensure health and safety in our manufacturing facilities. We require that our employees comply with such policies and measures and also provide training to our new employees and periodic training to our employees. To date, our manufacturing facilities have not encountered any material unplanned work stoppages due to health and safety issues. We have complied with applicable PRC laws and regulations on health, safety and other relevant administrative regulations issued by the local governments in the regions where we operate. To date, we have not been subject to any material fines, orders or administrative actions involving non-compliance with these laws and regulations relating to any of our existing manufacturing facilities.

 

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Insurance

We maintain property insurance to cover our fixed assets. Our insurance policy covers our six subsidiaries within the PRC and is renewed on an annual basis. The policy insures against damages to the insured property arising from events such as fire, floods and other natural disasters. We do not have product liability insurance coverage for our products. We do not carry liability insurance that extends coverage to all potential liabilities that may arise in the ordinary course of our business, and we do not maintain any insurance coverage for business interruption. We do not maintain key-man life insurance for our executive officers or employee liability insurance.

Although we consider our insurance coverage to be adequate and in line with our industry practice, our insurance coverage, however, may still not be sufficient to cover damage to our fixed assets. To date, we have not made or been subject to any material insurance claims.

Regulations

We operate our business in the PRC under a legal regime consisting of the laws enacted and adopted by the National People’s Congress of the PRC, or the NPC, and its Standing Committee, the administrative regulations promulgated by the State Council, the highest executive branch of the PRC government and the ministerial decrees adopted by several ministries and agencies directly under the State Council’s authority including, among others, the National Development and Reform Commission of the PRC, or the NDRC, the Ministry of Transport of the PRC, or the MOT, the MOFCOM, and the SAFE, and local rules promulgated by local governmental authorities at different levels. The following summarizes all material PRC laws and regulations that are relevant to our business.

Regulations on Automotive Components Industry

General Policies on Automotive Industry

The Policy on Development of the Automotive Industry was promulgated by the NDRC on May 21, 2004 and became effective on May 21, 2004 and amended on August 15, 2009 (the amendment became effective on September 1, 2009). The Middle and Long-Term Development Plan for the Automotive Industry was promulgated by the NDRC, the Ministry of Industry and Information Technology, and Ministry of Science and Technology in April 2017, which provides guiding ideology, basic principles and planning goals for the automotive industry.

The policy contains provisions relating to, among other things, technology policies, structure adjustments, market entry requirements, trademark usage, product development, spare parts sales, distribution networks, investment administration, customs administration and automobile consumption of automotive industry. The main objective of the policy was to develop the PRC automotive industry and make China a major automotive manufacturing country by 2010.

Under the policy, a series of favorable policies were released to encourage technology innovation by automotive components manufacturers and to attract social capital to automotive components industry to enhance competitiveness and expand production capacity of automotive components manufacturers with leading market positions. Automotive components manufacturers that are deemed as international manufacturers or are able to provide a full range of products to multiple auto makers are entitled to more favorable treatment in several aspects, including technology importation, technology improvement, financing and merger and acquisition.

Regulations on Quality Control of Automotive Components

The Circular on Further Enhancing the Automobile Sales and Quality Control of Automotive Components Manufacturing was jointly promulgated by the SAIC, the MOT and the General Administration of Quality Supervision, Inspection and Quarantine of the PRC on July 26, 2010. The circular authorizes local branches of the SAIC, the MOT, and the General Administration of Quality Supervision, Inspection and Quarantine to jointly establish an automotive component tracing system to enhance supervision on manufacturing, distribution and usage of automotive components.

Under the circular, local branches of the SAIC are required to enhance their inspection of packaging, branding and quality of automotive components in the market, in particular, branded automotive components in distributors’ stores. A penalty may be imposed on the distributor of the automotive components if any such product bears no signs of the manufacturer’s information, product name, name of distributor or quality certificate, or is not in compliance with the quality standard under applicable laws.

Product Liability

Under PRC laws, manufacturers and vendors of defective products in the PRC may be liable for loss and injury caused by such defective products. In accordance with the General Principles of the Civil Law of the PRC promulgated by the NPC on April 12, 1986, as amended on August 27, 2009, manufacturers and vendors of a defective product which causes property damage and/or personal injuries to any person are subject to civil liability for such damage and/or injuries.

 

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The Product Quality Law of the PRC was promulgated by the Standing Committee of the NPC on February 22, 1993, as amended on July 8, 2000, August 27, 2009 and December 29, 2018. Under the law, manufacturers who produce defective products are subject to civil and criminal liability and may have their business licenses revoked.

The Law of Protection of the Rights and Interests of Consumers was promulgated by the Standing Committee of the NPC on October 31, 1993 became effective on January 1, 1994 and was amended on August 27, 2009 and October 25, 2013. The law provides further protection to the legal rights and interests of consumers in connection with their purchase or use of goods and services. All business operations must observe and comply with the Consumers Protection Law when selling goods and offering services.

The Tort Law of the PRC was promulgated by the Standing Committee of the NPC on December 26, 2009 and became effective on July 1, 2010. The law establishes a separate chapter regarding product liability. Compared to other laws and regulations in relation to product liability, the law expressly provides that, in the event a defective product causes death or serious personal injury and the entity that manufactures and distributes such defective products has knowledge of the existence of such defects, such entity may be sued for punitive damages.

Other Regulations Relevant to Our Operation

Company Law

The Company Law of the PRC was promulgated by the Standing Committee of the NPC on December 29, 1993 and became effective on July 1, 1994 and was amended on December 25, 1999, August 28, 2004, October 27, 2005, December 28, 2013 and October 26, 2018.

Under the Company Law, the term “company” refers to a limited liability company or a joint stock limited company established within the PRC in accordance with the Company Law. Shareholders of a company are only responsible for the company or to the company’s creditors to the extent of the capital contributions they have made or the number of shares they have subscribed. The shareholders of a company are entitled to enjoy the capital proceeds, participate in making important decisions, including choosing managers.

In accordance with the Company Law, the registered capital of a limited liability company is the total amount of the capital contributions subscribed by all the shareholders that have registered with the SAIC or its local counterparts. The capital contributions can be made in cash or in kind, intellectual property, land use rights and other non-cash properties which can be evaluated in currency and transferred in accordance with the law, except for properties prohibited by laws and administrative regulations to be used for capital contribution.

Foreign Investment Law

On March 15, 2019, the NPC published the Foreign Investment Law, or the FIL, which took effect on January 1, 2020. The FIL applies to PRC enterprises established, acquired or otherwise invested wholly or partially by foreign investors in a manner prescribed under applicable PRC laws and regulations. With the Foreign Investment Law came into force, the three old laws regulating foreign investment in China, including the Wholly Foreign-Owned Enterprise Law, together with their implementation rules and ancillary regulations, were abolished.

Property

The properties that we lease and own in the PRC are subject to the Property Law of the PRC, which was promulgated by the Standing Committee of the NPC on March 16, 2007 and became effective on October 1, 2007. Under the law, any creation, modification, transfer or termination of property rights becomes effective only upon registration with the relevant government authorities. Ownership of all lawful properties of the State, collective organizations and individuals are protected.

The Land Administration Law of the PRC was promulgated by the Standing Committee of the NPC on June 25, 1986, became effective on January 1, 1987, and was amended on December 29, 1988, August 29, 1998, August 28, 2004 and August 26, 2019. According to the law, lands within the territory of the PRC fall into two categories: state-owned land and collectively-owned land. The use right of state-owned lands can be obtained through either government allocation or grant upon payment of appropriate grant fees. The law further provides that any construction must be conducted on state-owned lands except as otherwise permitted under the law. Collectively-owned lands may not be granted, assigned or leased for use of construction that is unrelated to agriculture unless otherwise permitted under the law. Violation of the law may result in facilities built thereon being demolished and, consequently, related businesses being forced to move to other locations.

Intellectual Property Rights

Patent

The Patent Law of the PRC was promulgated in 1984 and amended in 1992, 2000 and 2008. The law recognizes the right in patents and provides an enforcement framework for the protection of proprietary rights. Pursuant to the Patent Law, patents are effective for 20 years from the initial date the patent application was filed.

 

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Patent Prosecution

The PRC patent prosecution system adopts the principle of “first to file.” This means that, where more than one person files a patent application for the same invention, a patent will be granted to the person who first filed the application. The United States uses a principle of “first to discover” to determine the granting of patents. In addition, the PRC requires absolute novelty in order for an invention to be patentable. If a technology that is the subject of an invention patent application was known to the public prior to the filling of the application, then such technology is not qualified to be patented as an invention. In contrast, inventors in the United States have a one-year grace period after publication of the invention during which they may file a patent. Patents issued in the PRC are not enforceable in Hong Kong, Taiwan or Macau, each of which has an independent patent system. Patents are filed at the State Intellectual Property Office of the PRC, or the SIPO, in Beijing.

Patent Enforcement

A patent holder who believes his patent is being infringed may either file a civil legal suit or file an administrative complaint with a provincial or municipal office of the SIPO. A PRC court may issue a preliminary injunction upon the patent holder’s or an interested party’s request before instituting any legal proceedings or during the proceedings. Damages for infringement are calculated as either the loss suffered by the patent holder arising from the infringement or the benefit gained by the infringer from the infringement. If it is difficult to ascertain damages in this manner, damages may be determined in the range of from one to three times of the license fee under a contractual license. If damages still cannot be determined, statutory damages from RMB10,000 to 1,000,000 may apply. As in other jurisdictions, patent holders in the PRC have the burden of proving that a patent is being infringed, with one notable exception that if the holder of a manufacturing process patent alleges infringement of such patent, the alleged infringing party has the burden of proving that there has been no infringement.

International Patent Treaties

The PRC is also a signatory to all major intellectual property conventions, including the Paris Convention for the Protection of Industrial Property, the Madrid Agreement on the International Registration of Marks and Madrid Protocol, the Patent Cooperation Treaty, the Budapest Treaty on the International Recognition of the Deposit of Microorganisms for the Purposes of Patent Procedure and the Agreement on Trade-Related Aspects of Intellectual Property Rights.

Although patent rights are national rights, there is also a large degree of international co-operation under the Patent Cooperation Treaty, to which the PRC is a signatory. Under the treaty, applicants in one country can seek patent protection for an invention simultaneously in a number of other member countries by filing a single international patent application. The fact that a patent application is pending is not a guarantee that a patent will be granted, and even if granted, the scope of a patent may not be as broad as the subject of the initial application.

Trademark

The Trademark Law of the PRC was promulgated by the Standing Committee of the NPC on August 23, 1982, and was amended on February 22, 1993, October 27, 2001, August 30, 2013, and April 23, 2019. The PRC Trademark Law Implementation Rules was promulgated by the State Council on August 3, 2002 and became effective on September 15, 2002 and was amended on April 29, 2014. The PRC is a signatory country to the Madrid protocol. The Madrid protocol provides for a mechanism under which an international registration produces the same effects as an application for registration of the trademark made in each of the countries designated by the applicant. According to the trademark law, the National Trademark Bureau under the State Administration for Market Regulation (“SAMR”) is responsible for the registration and administration of trademarks in the PRC. A “first-to-file” principle with respect to trademarks has been adopted. Where a trademark is infringed, the trademark owner may file a complaint with the relevant administrative department or competent courts. Where the infringement is so serious that it constitutes a crime, the trademark owner may file a complaint with the relevant public security organization. If a registered trademark owner intends to assign his or her registered trademarks, a registered trademark transfer agreement must be entered into between the owner and the assignee. The owner and assignee are required to jointly apply with the National Trademark Bureau and its local counterparts for registration of such assignment under the Trademark Law. Registered trademark owners may license others to use their registered trademarks. Relevant license agreements shall be filed with the National Trademark Bureau or its relevant local counterparts.

Domain Names

On August 24, 2017, the Administrative Measures for Internet Domain Names were promulgated by the Ministry of Industry and Information Technology, which specified the administrative authority, license and administration of domain name service providers and protection of personal information. The Measures on Domain Names Dispute Resolution were promulgated by the China Internet Network Information Center on September 25, 2002 and became effective on September 30, 2002, and was amended in 2006, 2012 and 2014. The dispute resolution measures require domain name disputes to be submitted to institutions authorized by the China Internet Network Information Center for resolution.

 

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Environmental Protection

The Environmental Protection Law of the PRC was promulgated on December 26, 1989 by the Standing Committee of the NPC and became effective on December 26, 1989, and amended on April 24, 2014. The law establishes the legal framework for environmental protection in the PRC. The Ministry of Ecology and Environment under the State Council is primarily responsible for the supervision and administration of environmental protection work nationwide and formulating national waste discharge limits and standards. Local environmental protection authorities at the county level and above are responsible for environmental protection in their jurisdictions.

The Law on Prevention and Control of Environmental Pollution by Solid Wastes was promulgated by the NPC on October 30, 1995 and amended on December 29, 2004, June 29, 2013, April 24, 2015 and November 7, 2016. Entities that do not have business licenses and qualifications are prohibited from the collection, storage, utilization and treatment of hazardous wastes. Parties that violate these provisions will be ordered to stop and correct such violation within a specified period of time or will be subject to a fine.

Labor Law

According to the Labor Contract Law which became effective on January 1, 2008 and was amended on December 28, 2012, labor contracts must be entered into if labor relationships are to be established between an entity and its employees. An employer may not require its employees to work in excess of the time limit permitted under the relevant labor laws and regulations and must pay the employees’ wages that are no lower than the minimum wages under local standards. According to the Labor Contract Law and the Safe Production Law of the PRC, employers in the PRC are required to establish and perfect its system for labor safety and sanitation, comply with rules and standards relating to labor safety and sanitation, educate employees on labor safety and sanitation.

Foreign Currency Exchange

Foreign currency exchange in the PRC is primarily governed by the Foreign Exchange Administration Rules and the Regulations of Settlement, Sale and Payment of Foreign Exchange.

Under the Amended Foreign Exchange Administration Rules, which became effective on August 5, 2008, Renminbi is freely convertible for current account items, including the distribution of dividends payments, interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account items, such as direct investment, loans, securities investment and repatriation of investment, however, is still generally subject to the approval or verification of the SAFE.

Under the Regulations of Settlement, Sale and Payment of Foreign Exchange, promulgated in 1996, foreign invested enterprises, or FIEs, including WFOEs, may buy, sell or remit foreign currencies only at those banks that are authorized to conduct foreign exchange business after providing such banks with valid commercial supporting documents and, in the case of capital account item transactions, after obtaining approvals from the SAFE. Capital investments by FIEs outside the PRC are also subject to limitations, which include approvals by the MOFCOM, the SAFE and the NDRC.

On August 29, 2008, the SAFE promulgated Circular 142, which stipulates that the registered capital of an FIE may only be used for the purpose within its approved business scope and shall not be used for equity investment within the PRC. Violations of Circular 142 may result in penalties, including fines as set forth in the Foreign Exchange Administration Rules. On March 30, 2015, the SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administrative Approach Regarding the Settlement of the Foreign Exchange Capitals of Foreign-invested Enterprises, or Circular 19 and on June 9, 2016, the Circular of the State Administration of Foreign Exchange on Reforming and Standardizing the Administrative Provisions on Capital Account Foreign Exchange Settlement, or Circular 16, which replaced Circular 142 and stipulates that foreign exchange earnings under capital account to which the application of voluntary settlement has been specified by relevant policies may be settled by banks based on the actual operating needs of domestic institutions. PRC enterprises may use its foreign exchange earnings under capital account and the Renminbi funds obtained from the settlement thereof for current account expenditure within the scope of its business, as well as for capital account expenditure permitted by laws and regulations, but the use of equity investment is still restricted. On October 25, 2019, the SAFE promulgated the Notice of the State Administration of Foreign Exchange on Further Promoting the Facilitation of Cross-border Trade and Investment (Circular No.28), which stipulates that non-investment-oriented foreign-invested enterprises shall be allowed to use capital funds for domestic equity investment in accordance with the law under the premise of not violating the existing special management measures for entry of foreign investment (negative list) and the authenticity and compliance of their domestic invested projects.

 

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Foreign Exchange Regulations on Special Purpose Vehicles

In July 2014, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Overseas Investment and Financing and Reverse Investment Activities of Domestic Residents Conducted via Special Purpose Companies, or Notice 37, which became effective as of July 4, 2014, and replaced the previous Notice 75. Notice 37 maintain the registration requirement of PRC residents with the local SAFE branch for establishing or controlling any offshore company for the purpose of investment, and financing and conducting reverse investment in China with the domestic or overseas asset or equity that they legally hold, which is referred to as a “Special Purpose Vehicle” under Notice 75. It further requires amendment to a PRC resident’s registration in the event of significant changes to a Special Purpose Vehicle, such as an increase or decrease of capital, share transfer or exchange, merger, division or other material event. Notice 37 provides clearer guidance and procedures for the registration requirements compared to Notice 75. In addition, different local SAFE branches may have different views and procedures as to the interpretation and implementation of the SAFE regulations.

Under the relevant rules, failure to comply with the registration procedures set forth in Notice 37 may result in restrictions being imposed on the foreign-exchange activities of the relevant onshore company, including the payment of dividends and other distributions to its offshore parent or affiliate and the capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign-exchange administration regulations.

If any PRC shareholder of our company, which is an offshore company, fails to make the required SAFE registration and amendment registration, the PRC subsidiaries of our company may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to our company. In addition, failure to comply with the SAFE registration and amendment registration requirements described above could result in liability under the PRC laws for evasion of applicable foreign-exchange restrictions and subject us to large fines. We require all our shareholders who are PRC residents to comply with any SAFE registration requirements, but we have no control over either our shareholders or the outcome of such registration procedures. Such uncertainties may materially and adversely affect our business and prospects.

Regulations on Mergers and Acquisitions by Foreign Investors

On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the SASAC, the STA, the SAIC, the CSRC, and the SAFE, jointly promulgated the 2006 M&A Rule, which became effective on September 8, 2006 and were amended on June 22, 2009. The 2006 M&A Rule, among other things, includes provisions that purport to require that an offshore special purpose vehicle formed for the purpose of an overseas listing of securities in a PRC company obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. On September 21, 2006, the CSRC issued a clarification that sets forth the criteria and process for obtaining any required approval of overseas listings by special purpose vehicles. However, substantial uncertainty remains regarding the scope and applicability of the 2006 M&A Rule to offshore special purpose vehicles.

The application of the 2006 M&A Rule with respect to our initial public offering and our corporate structure remains unclear. Our PRC counsel has advised us that we were not required to apply with any relevant PRC regulatory agencies, including the CSRC, for approval of our initial public offering or the current corporate structure for our initial public offering.

In addition, on February 3, 2011, the State Council promulgated the Security Review Rule, which became effective 30 days after February 3, 2011. The Security Review Rule, among other things, provides that merger and acquisition transactions by foreign investors of domestic enterprises in sensitive sectors or industries may be subject to security review and, as a result may be blocked due to their impact on the national defense security, national economic stability, basic social life order, or capacity of indigenous research and development of key technologies.

Regulations on Employee Share Options

On March 28, 2007, SAFE promulgated the Share Option Rule. On February 15, 2012, SAFE issued the Stock Incentive Plan Rule which replaced the Share Option Rule. Under the Stock Incentive Plan Rule, PRC citizens who are granted share options or other employee equity incentive awards by an overseas publicly-listed company are required, through a qualified PRC agent or a PRC subsidiary of such overseas publicly-listed company, to register with the SAFE and complete certain other procedures related to the share options or other employee equity incentive plans. We and our PRC citizen grantees are subject to these regulations. If we or our PRC citizen grantees fail to comply with these regulations, we or our PRC citizen grantees may be subject to fines and other legal or administrative sanctions.

 

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C.	Organizational Structure

The following diagram illustrates our corporate structure as of June 11, 2020:

 

 

D.	Property, Plants and Equipment

We are headquartered in Zhangzhou, Fujian Province where we have our manufacturing facilities (including our main administrative offices, a research and development center, a test center and employee dormitories) with an aggregate floor area of approximately 121,630 square meters. We also have five other manufacturing facilities (including offices and employee dormitories) in Langfang, Hebei Province; Chengdu, Sichuan Province; Hefei, Anhui Province; Benxi, Liaoning Province; and Hua’an, Fujian Province with an aggregate floor area of approximately 138,040 square meters, 47,303 square meters, 45,870 square meters, 26,740 square meters and 65,000 square meters, respectively. Each of our manufacturing facilities in Langfang, Hebei Province; Hefei, Anhui Province; and Hua’an, Fujian Province includes a research and development center. Our manufacturing facility in Hua’an, Fujian Province also include a test center. We have obtained land use rights and property ownership certificates for all these manufacturing facilities. In addition, certain of our manufacturing facilities have been pledged to secure our bank borrowings, which amounted to RMB180.0 million , RMB180.0 million and RMB180.0 million (US$25.9 million) as of December 31, 2017, 2018 and 2019, respectively.

 

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Item 4A.

Unresolved Staff Comments

Not applicable.

 

Item 5.

Operating and Financial Review and Prospects

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with Item 3A “Key Information — Selected Financial Data” and our audited consolidated financial statements and the related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Item 3D “Key Information — Risk Factors” and elsewhere in this annual report.

A. OPERATING RESULTS

Overview

We are one of the largest commercial wheel manufacturers in the PRC in both the aftermarket and OEM market in terms of sales volume, and we have maintained significant market share in recent years. We believe that our products enjoy premium brand recognition in the industry, especially among end-users. We also export our products to more than 30 countries worldwide.

We design, manufacture and sell high quality steel and aluminum wheels that are widely used by most types of commercial vehicles. Our product offering is one of the most diversified in the PRC commercial wheel industry. We currently offer more than 883 series of tubed steel wheels, tubeless steel wheels, off-road steel wheels and aluminum wheels. Each series of steel wheels comes in a range of performance specifications, sizes and colors to meet the various requirements of our customers.

We have a diversified customer base with our products being sold in both the aftermarket and OEM market in the PRC and internationally. We sell our products to end-users in the PRC aftermarket through our nationwide distribution network, which we believe is one of the most extensive distribution networks among commercial wheel manufacturers in the PRC. As of December 31, 2019, our distribution network consisted of more than 3,261 distributors, including 23 tier-one distributors, 2,120 exclusive tier-two distributors and 1,118 non-exclusive tier-two distributors, throughout the PRC. Our OEM customers included more than 77 automotive manufacturers in the PRC as of December 31, 2019, including the group members of a number of large PRC commercial vehicle manufacturers. In international markets, we sold our products to more than 60 distributors in the aftermarket as of December 31, 2019, including Li Li Ai of Burma, AUTO JAYA of Indonesia, Oliver of the Philippines, UNIVERSAL AUTO ENGG. of Pakistan and Well Product Trading LP of Thailand. Vietnam was our largest international market in 2017, and Thailand was our largest international market in 2018 and 2019.

In 2017, 2018 and 2019, we generated revenue of RMB2,831.0 million, RMB3,149.6 million and RMB2,493.2 million (US$358.1 million), respectively, and recorded a profit of RMB9.1 million, a loss of RMB 8.0 million, and a loss of of RMB104.9 million (US$15.1 million), respectively.

Factors Affecting Our Results of Operations

We believe that the following are the most significant factors affecting our financial condition and results of operations.

 

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General Economic Conditions and Growth of the Automotive Market in the PRC and Worldwide

Our financial condition and results of operations have been, and we expect them to continue to be, dependent to a significant extent on the general economic conditions and growth of the automotive industry in the PRC and in other target markets, such as Thailand, which has been our largest international market from 2013 to 2016 and in 2018 and 2019. We sell steel wheels through a network of distributors to aftermarket end-users as replacements for worn out or lower quality wheels. The actual demand from both aftermarket end-users and OEMs customers depends on the overall demand for and usage of commercial vehicles, which in turn depends on a number of factors including overall economic conditions, vehicle sales and availability and quality of transportation networks in the markets where we sell and distribute our products.

As the PRC economy developed, domestic commercial vehicle sales had enjoyed a relatively long period of growth, which partially drove the domestic sales of our products. Further, the gradual increase in commodities prices stimulated market trading and drove the development of the logistics and transportation sector. Simultaneously, integration of the logistics sector and the production of more efficient and high-end vehicles also boosted the heavy-duty truck sector. The implementation of the “One Belt, One Road” policy to redevelop the southern silk road and strengthen international cooperation on production capacity in South and Southeast Asia will help support the export of heavy-duty trucks. A combination of these developments led to an increase in demand for new heavy-duty trucks in 2017. In 2018, the PRC automotive industry remained largely stable, despite the slowdown of the PRC annual GDP growth to 6.6%, the slowest since 1990. This was mainly due to the combined effects of the Chinese government’s anti-truck overloading policy, supply-side reforms and higher fixed asset investments, which revitalized demand for new trucks. In 2019, as a result of the economic slowdown and the fading effects of the Chinese government’s earlier stimulus policies, demand for new trucks decreased.

Sales outside the PRC were mainly generated from the Southeast Asian market, particularly with respect to Thailand and Vietnam. The challenges we face in our offshore markets are mainly related to the strength of the Renminbi relative to the local currencies, competition from local manufacturers, and preferential trade policies. We also face competition from PRC manufacturers seeking to export their products to the same offshore markets. Generally, during 2017, 2018 and 2019, Southeast Asian currencies depreciated, but their economic conditions and expansions remained robust. Excess production capacity in wheel manufacturing, however, continued to plague the PRC market, and competition in export pricing remained intense. Notwithstanding this, we kept our focus on the Southeast Asian market and will continue to explore this new market for high value-added products.

The implementation, renewal, change or cancellation of any government policies in the future, such as economic stimulus or tightening measures or currency controls, in the PRC or in any of the target international markets, may significantly affect our business. If the demand for our wheels declines as a result of changes of economic conditions in the automotive industry or does not grow at the pace we anticipate, our business, financial condition, results of operations and prospects could be harmed.

Competition and Prices of Our Products

Our products are targeted for sale in two sectors: the aftermarket and OEM market. In the aftermarket, the key competitive factors are price, product quality, product diversification, brand reputation, technology and ability to develop new products, delivery timeliness, after-sales service and customer relationships. In the OEM market, the same factors apply, except that OEMs are relatively more concerned with their suppliers’ production scale rather than product diversification or brand reputation. Our products are priced based on a variety of factors, including macro economic conditions, supply and demand for our products in the market, product quality and the terms of our arrangements with customers.

We believe that as a result of our large market share, premium brand recognition and high product quality, we have been able to charge a slight premium for our products. Also, as wheels generally extend the useful lives of tires, which are usually more expensive than wheels, we believe that wheels are typically less subject to downward price pressure by end-users and end-users are usually willing to pay higher prices for high-quality wheels like ours, thus strengthening our ability to set the prices of our products. The average selling prices of our products in the aftermarket tend to be slightly higher than that in the OEM market, both in the PRC and internationally. Our average selling prices increased in 2017 compared with 2016 due to an improvement in the macroeconomic condition in the PRC. In 2018, the domestic selling prices were relatively stable mainly due to the combined effect of price increase driven by higher material prices, the effects of which were mitigated by the weak macroeconomic condition. In 2019, the domestic selling prices slightly decreased compared with 2018 due to slowdown in economic growth and intense competition. In the first half of 2020, the COVID-19 pandemic seriously affected the PRC economy, creating pressure on our performance in the short to medium term; however, in the long term, we expect the market condition in the PRC to keep improving, which will lead to an increase in domestic demand for heavy duty trucks as domestic spending on infrastructure and property construction continues to increase at a steady pace. Sharp fluctuations in market demand could adversely affect our prices in future periods. Moreover, if through larger production scale, superior product quality, better technology or other factors, a competitor gains the pricing power that we currently enjoy, our prices and sales volume would be adversely affected. A weak OEM market would also affect the aftermarket segment in China as competition intensifies and pricing pressure increases.

 

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In our international markets, our prices are usually set by reference to the prevailing market prices in our target markets, as well as the factors affecting pricing listed above. Our pricing outside the PRC is also affected by such factors as RMB foreign exchange rates in terms of our sales price, the strengths of the local currency from the perspective of the buyers and government regulations such as import and export taxes.

Cost and Availability of Steel

Our principal raw material is steel, which accounts for a substantial amount of our total raw material requirements. We purchase steel from a limited number of reputable suppliers in the PRC. We generally enter into framework agreements with our steel suppliers pursuant to which we place orders from time to time. These agreements typically set a purchase amount and are renewed every year upon mutual agreement. The actual purchase price and amount of steel vary from order to order. Prices of steel are subject to fluctuation depending on supply and demand in the market, and we generally are able to purchase steel at prices slightly lower than the prevailing market prices because of our large volume of purchases.

It is crucial to our business that we obtain from our suppliers sufficient quantities of steel meeting our specifications in a timely manner and at competitive prices for our production. We have long-term relationships with most of our steel suppliers, and to date, have not experienced any shortage of steel for our production. If one or more of our principal steel suppliers fails to meet our purchase orders, we believe that we can obtain steel from alternative suppliers, but we may experience a delay in deliveries in that case, which could adversely affect our production. Moreover, fluctuations in the prices of steel and our ability to pass on any increase in raw material costs to our customers will affect our cost of sales and our gross profit margins. Because of our leading market position and the strong demand for our products, we believe we generally are able to set the prices of our products at a premium and pass on any significant increases in our raw material costs to our customers. Depending on the intensity of competition in the market, we generally reduce the selling prices of our products when there are significant decreases in our raw material costs.

In the past few years, fluctuation in the price of steel has affected the prices of our products in part. The increase in the price of steel pushes up the prices of our products. However, with intense market competition, the increase in the prices of our products is slower than the increase in the price of steel while the decrease in the price of steel would cause timely reduction in the prices of our products. The average selling prices of our products increased in 2017 and slightly increased in 2018, predominantly due to an increase in the price of steel. In 2019, the average selling prices of our products decreased due to a decrease in the price of steel.

Product Research and Development and Product Mix

Our success will depend significantly on our ability to stay at the forefront of product development and production technology in the commercial wheel industry in the PRC and internationally. Accordingly, we are committed to the research and development of new models of wheels, as well as ongoing enhancements in existing product quality and production technology. Nevertheless, we cannot be certain that our research and development activities will be successful or that our product mix will continue to be competitive in the commercial wheel market, particularly as we expand into other types of products such as aluminum wheels.

In addition, our results of operations are to a certain extent affected by our product mix, as different products have different profitability. We generally adjust our product mix in favor of more profitable products. For example, we have allocated more weight to tubeless steel wheels in our product mix in recent years, as tubeless steel wheels generally have a higher gross profit margin than tubed steel wheels. If the profitability of different wheel products change and we fail to reflect such changes in our product mix, our results of operations may be adversely affected.

Our International Sales and International Expansion Plans

International sales as a percentage of our revenue have been, and are expected to continue to be, affected by the conditions of the global economy and the automotive industry. Therefore, our international sales can be unstable. Furthermore, our international sales generally have a lower gross profit margin compared to our sales in the PRC, primarily due to lower product prices in our international markets and a higher proportion of our international sales being tubed steel wheels, instead of tubeless steel wheels for which we have a higher gross profit margin.

As a result, our operations and financial performance are affected by the social, economic, political and regulatory conditions in our target markets. Furthermore, regulations and policies affecting trade and bilateral relations between the PRC and the countries and regions to which we export our products can adversely affect our international sales in those countries and regions.

When exporting to international markets, we may be subject to import taxes, duties or other barriers to free trade. Although we do not believe that we have engaged in anti-competitive behavior, we cannot be certain whether anti-dumping duties, taxes or other charges will be imposed against us in the future and to what extent such duties, taxes or other charges, or other regulatory changes in the international markets where we sell our products will adversely affect our business.

Therefore, we cannot assure you that we will be able to maintain or increase our revenue derived from international sales or that we will be able to benefit from our international expansion plans.

 

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Components of Results of Operations

Revenue

Our revenue is primarily derived from sales of steel wheels, including tubed, tubeless and off-road steel wheels, and aluminum wheels for use in commercial vehicles. We sell our products to (i) tier-one distributors in the PRC, which then resell our products to end-users in the PRC aftermarket through tier-two distributors, (ii) OEMs in the PRC, and (iii) international distributors and OEMs. We categorize our business into three operating segments based on these sales channels: (i) PRC aftermarket sales, (ii) PRC OEM sales, and (iii) international sales. Our revenue represents the consideration received or receivable for our goods sold, net of related taxes, sales rebates and discounts. Depending on the contractual arrangement with our customers, sales are recognized when control of the products has been transferred, being when the risks and rewards have been transferred, the customer has full discretion over the channel and price to sell the products, and there is no unfulfilled obligation that could affect the customer’s acceptance of the products.

PRC aftermarket sales accounted for 32.1%, 31.8% and 36.3% of our revenue in 2017, 2018 and 2019, respectively. PRC OEM sales accounted for 54.2%, 55.8% and 52.2%, respectively, of our revenue for the same periods. International sales accounted for 13.7%, 12.4% and 11.5%, respectively, of our revenue for the same periods.

PRC aftermarket sales as a percentage of our revenue decreased from 32.1% in 2017 to 31.8% in 2018 and increased to 36.3% in 2019. The aftermarket wheel segment remained weak and was negatively affected by the increased number of new vehicles on the road over the past few years, a demand shift to lower-price products and the Chinese government’s heightened anti-overloading enforcement.

PRC OEM market sales as a percentage of our revenue increased from 54.2% in 2017 to 55.8% in 2018 and decreased to 52.2% in 2019, as a result of weak vehicle sales to our large OEM customers, especially heavy- and medium-duty trucks.

International sales as a percentage of our revenue decreased from 13.7% in 2017 to 12.4% in 2018 and 11.5% in 2019, as weaker demand in price sensitive regions such as Southeast Asia negatively affected overall sales. We expect international sales as a percentage of our revenue to continue to be affected by both global economic trends and local conditions.

Sales of tubed steel wheels accounted for 45.4%, 46.1% and 45.1% of our revenue in 2017, 2018 and 2019, respectively. Sales of tubeless steel wheels accounted for 43.9%, 41.1% and 40.8%, respectively, of our revenue for the same periods. We commenced sales of off-road steel wheels in 2008 which accounted for 1.8%, 1.6% and 2.2% of our revenue in 2017, 2018 and 2019, respectively. We commenced sales of aluminum wheels in the third quarter of 2015 which accounted for 6.8%, 8.9% and 9.8% of our revenue in 2017, 2018 and 2019, respectively. We expect the upward trend shown in our sales of aluminum wheels as a percentage of our revenue to continue in the long-term when the COVID-19 pandemic situation stabilize as a result of the increase in market acceptance of aluminum wheel. Sales of wheel components accounted for 2.1%, 2.3% and 2.1% of our revenue in 2017, 2018 and 2019, respectively. We expect sales of tubed steel wheels as a percentage of our revenue to decrease and sales of tubeless steel wheels as a percentage of our revenue to increase in the long-term, primarily due to the overall market trend of the gradual replacement of tubed steel wheels by tubeless steel wheels.

 

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The following table sets forth the breakdown of our revenue by sales channel/operating segment for the periods indicated:

 

		Year Ended December 31,
		2017								2018								2019								2019
		RMB				% of Revenue				RMB				% of Revenue				RMB				% of Revenue				US$				% of Revenue
		(in thousands, except percentages)
PRC OEM sales			1,533,044				54.2				1,758,057				55.8				1,302,273				52.2				187,060				52.2
PRC aftermarket sales			909,929				32.1				1,002,519				31.8				903,548				36.3				129,786				36.3
International sales			388,014				13.7				389,038				12.4				287,397				11.5				41,282				11.5
Total			2,830,987				100.0				3,149,614				100.0				2,493,218				100.0				358,128				100.0

The following table sets forth the breakdown of our revenue by product category for the periods indicated:

 

		Year Ended December 31,
		2017								2018								2019								2019
		RMB				% of Revenue				RMB				% of Revenue				RMB				% of Revenue				US$				% of Revenue
		(in thousands, except percentages)
Tubed steel wheels			1,286,535				45.4				1,452,696				46.1				1,124,025				45.1				161,456				45.1
Tubeless steel wheels			1,242,528				43.9				1,294,187				41.1				1,017,510				40.8				146,157				40.8
Off-road steel wheels			51,451				1.8				48,917				1.6				55,248				2.2				7,936				2.2
Aluminum wheels			191,868				6.8				281,150				8.9				243,174				9.8				34,930				9.8
Wheel components			58,605				2.1				72,664				2.3				53,261				2.1				7,649				2.1
Total			2,830,987				100.0				3,149,614				100.0				2,493,218				100.0				358,128				100.0

Cost of Sales

Cost of sales primarily consists of (i) raw material costs, (ii) manufacturing overhead costs such as depreciation of property, plant and equipment and depreciation of right-of-use assets used for production purposes, and utilities and auxiliary materials associated with the manufacturing of our products, and (iii) direct labor costs.

The following table sets forth the breakdown of our cost of sales for the periods indicated:

 

		Year Ended December 31,
		2017								2018								2019								2019
		RMB				% of Cost of Sales				RMB				% of Cost of Sales				RMB				% of Cost of Sales				US$				% of Cost of Sales
		(in thousands, except percentages)
Raw material costs			1,893,145				77.3				2,220,505				79.8				1,772,070				78.2				254,542				78.2
Utilities and auxiliary materials			238,807				9.7				241,224				8.7				192,694				8.5				27,679				8.5
Depreciation and amortization			111,140				4.5				112,582				4.1				111,938				4.9				16,079				4.9
Direct labor costs			180,683				7.5				179,926				6.5				167,056				7.4				23,996				7.4
Taxes			25,624				1.0				25,531				0.9				21,660				1.0				3,111				1.0
Total			2,449,399				100.0				2,779,768				100.0				2,265,418				100.0				325,407				100.0

Other Income, Gain and Loss

Other income, gain and loss primarily consists of (i) interest income, (ii) net gain/(loss) from sales of scrap materials, (iii) insurance payments as reimbursement of directors and officers litigation costs and (iv) government grants. Government grants primarily consist of grants, subsidies and similar incentives for which we apply and that we periodically receive from various PRC government authorities mainly in relation to our capital expenditures and research and development efforts. We do not receive government grants on a regular basis, and the amounts that we have received in the past have fluctuated. While we intend to continue to apply for government grants in the future, there can be no assurance that we will receive any such grants. Sales of scrap materials represent sales of scrap steel generated in our manufacturing process to third parties or recycling stations.

Net Exchange (Losses)/Gains

Net exchange (losses)/gains represent losses or gains arising from the translation of monetary assets and liabilities (primarily associated with trade receivables and cash balances from our international sales) denominated in foreign currencies and U.S. dollars from such currencies to our functional currency, Renminbi.

 

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