SORL SORL Auto Parts Inc

NOTE B - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All intercompany balances and transactions have been eliminated in the consolidation. Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted as permitted by the rules and regulations of the United States Securities and Exchange Commission (“SEC”), although the Company believes that the disclosures contained in this report are adequate to make the information presented not misleading. The consolidated balance sheet information as of December 31, 2018 was derived from the consolidated audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. These consolidated financial statements should be read in conjunction with the annual consolidated audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, and other reports filed with the SEC.

The accompanying unaudited interim consolidated financial statements reflect all adjustments of a normal and recurring nature which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. The results of operations for these periods are not necessarily comparable to, or indicative of, results of any other interim period or for the fiscal year taken as a whole.

The Company uses the accrual method of accounting for financial statement and tax return purposes.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes its best estimate of the outcome for these items based on historical trends and other information available when the financial statements are prepared. Changes in estimates are recognized in accordance with the accounting rules for the estimate, which is typically in the period when new information becomes available to management. Actual results could differ from those estimates.

For certain of the Company’s financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, bank acceptance notes from customers, inventories, current prepayments, current portion of deposits on loan agreements, other current assets, accounts payable and bank acceptance notes to vendors, short term bank loans, deposit received from customers, current portion of long term loans, deferred income, income tax payable, accrued expenses and other current liabilities, the carrying amounts approximate fair values due to their short maturities.

Transactions involving related parties cannot be presumed to be carried out on an arm’s-length basis, as the requisite conditions of competitive, free market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm’s-length transactions unless such representations can be substantiated. It is not, however, practical to determine the fair value of amounts due from/to related parties due to their related party nature.

Restricted cash, current consists of bank deposits used to pledge bank acceptance notes, and deposits for obtaining letters of credit from a local bank. 

Restricted cash, non-current consists of deposits guaranteed for construction projects and the non-current portion of certain bank deposits used to pledge for bank acceptance notes.

A related party is generally defined as (i) any person that holds 10% or more of the Company’s securities and their immediate families, (ii) the Company’s management, (iii) someone that directly or indirectly controls, is controlled by or is under common control with the Company, or (iv) anyone who can significantly influence the financial and operating decisions of the Company. A transaction is considered to be a related party transaction when there is a transfer of resources or obligations between related parties. The Company conducts business with its related parties in the ordinary course of business.

Bank acceptance notes from customers, generally due within six months and with specific payment terms and definitive due dates, are comprised of the notes issued by some customers to pay certain outstanding receivable balances to the Company, and the notes issued by the customers of related parties and transferred to the Company as loans from related parties or repayments from related parties. Bank acceptance notes do not bear interest. As of June 30, 2019 and December 31, 2018, bank acceptance notes receivable in the amount of $68,238,401 and $58,458,890, respectively, were pledged to banks to issue either short term bank loans or bank acceptance notes to vendors. The banks charge discount fees if the Company chooses to discount the bank acceptance notes for cash before the maturity of the notes and such discount fees are included in interest expenses in the accompanying unaudited consolidated statements of income and comprehensive income (loss).

The Company maintains its books and accounting records in RMB, the currency of the PRC. The Company’s functional currency is also RMB. The Company has adopted FASB ASC 830-30 in translating financial statement amounts from RMB to the Company’s reporting currency, United States dollars (“US$”). All assets and liabilities are translated at the current rate. The stockholders’ equity accounts are translated at the appropriate historical rate. Revenue and expenses are translated at the weighted average rates in effect on the transaction dates.

Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

NOTE C - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

On January 1, 2019, the Company adopted Accounting Standards Update (ASU) 2016-02, Leases (as amended by ASU 2018-01, 2018-10, 2018-11, 2018-20, and 2019-01, collectively ASC Topic 842), using the modified retrospective method. The Company elected the transition method which allows entities to initially apply the requirements by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As a result of electing this transition method, previously reported financial information has not been restated to reflect the application of the new standard to the comparative periods presented. The Company elected the package of practical expedients permitted under the transition guidance within ASC 842, which among other things, allows the Company to carry forward certain historical conclusions reached under ASC Topic 840 regarding lease identification, classification, and the accounting treatment of initial direct costs. The Company elected not to record assets and liabilities on its consolidated balance sheet for new or existing lease arrangements with terms of 12 months or less. The Company recognizes lease expenses for such leases on a straight-line basis over the lease term. In addition, the Company elected the land easement transition practical expedient and did not reassess whether an existing or expired land easement is a lease or contains a lease if it has not historically been accounted for as a lease.

The primary impact of applying ASC Topic 842 is the initial recognition of $1.6 million of lease liabilities and corresponding right-of-use assets on the Company’s consolidated balance sheet as of January 1, 2019, for leases classified as operating leases under ASC Topic 840, as well as enhanced disclosure of the Company’s leasing arrangements. There is no cumulative effect to retained earnings or other components of equity recognized as of January 1, 2019 and the adoption of this standard did not impact the consolidated statement of income and comprehensive income or consolidated statement of cash flows of the Company. The Company does not have finance lease arrangements as of June 30, 2019. See Note N for further discussion.

The Company continues to purchase primarily packaging materials from Ruili Group. In addition, the Company purchases automotive components from other related parties, including Guangzhou Kormee, Ruian Kormee, Ruili Meilian, Shanghai Dachao, Wenzhou Lichuang, Hangzhou Hangcheng, and molds from Ningbo Ruili used in its production.

The Company sells certain automotive products to the Ruili Group. The Company also sells parts to Guangzhou Kormee, Shanghai Tabouk, Ruian Kormee, Changchun Kormee and Ruili Meilian. 

The following related party transactions occurred for the three and six months ended June 30, 2019 and 2018:

From time to time, the Company borrows from Ruili Group and its controlled companies for working capital purposes. In order to obtain the loans and mutually benefit both the debtor and creditor of the arrangement, the Company also advances to Ruili Group and its controlled companies in a short term. All the loans from related parties are non-interest bearing, unsecured and due on demand. The advances to Ruili Group are unsecured and due on demand, and the Company charged them an interest on the average balance advanced to them. The Company recorded interests $2,507,133 during the six months ended June 30, 2019, representing an effective interest rate of approximately 6.45%.

During the six months ended June 30, 2019, the Company obtained net proceeds of $1,843,951 from a related party. In the same period, Ruili Group repaid the Company net amount of $5,543,910.

The Company entered into a lease agreement with Ruili Group. See Note N for more details. 

The Company provided a guarantee for the credit line granted to Ruili Group by the China Merchants Bank RMB 40,000,000 (approximately $5,828,185) for a period of 12 months starting on October 24, 2016. The credit line was renewed on October 19, 2017 for 6 months. On April 13, 2018, Ruili Group and the bank reached another extension agreement and the guarantee was provided by the Company until April 12, 2019.

The Company provided a guarantee for the credit line granted to Ruili Group by Bank of Ningbo in a maximum amount of RMB 210,000,000 (approximately $30,597,972) for the period from July 20, 2018 to July 20, 2028.

The Company provided a guarantee for the credit line granted to Ruili Group by China Guangfa Bank in a maximum amount of RMB71,000,000 (approximately $10,345,029) for the period from February 12, 2019 to January 16, 2020.

The Company provided a guarantee for the credit line granted to Ruili Group and SHNS Precision by Minsheng Bank in a maximum amount of RMB500,000,000 (approximately $72,730,446) for the period from June 6, 2019 to June 6, 2020.

The Company has short term bank loans guaranteed or pledged by related parties. See Note J for more details.

No customer individually accounted for more than 10% of our revenues or accounts receivable for the six months ended June 30, 2019 and 2018. The changes in the allowance for doubtful accounts at June 30, 2019 and December 31, 2018 are summarized as follows:

The write-down of inventories amounted to $852,266 and $nil for the six months ended June 30, 2019 and 2018, respectively.

Depreciation expense charged to operations was $6,395,006 and $5,531,002 for the six months ended June 30, 2019 and 2018, respectively.

In December 2017, the Company entered into an agreement with the Ministry of Land and Resources, Ruian, to purchase the land use rights for the land located at the intersection of Fengjin Road and Wenhua Road, Binhai New District, Ruian City, Zhejiang Province, China. As of December 31, 2018, the purchase price of RMB 72.02 million (approximately $11.13 million) was fully paid. As of the filing date, the title to the land use rights has not been transferred. The payments were included as prepayment, non-current as of June 30, 2019 and December 31, 2018 on the accompanying consolidated balance sheets.

In April 2018, the Company entered into an agreement with the Ministry of Land and Resources, Ruian, to purchase the land use rights for the land located at the intersection of Tengda Road and Wanghai Road, Economic Development District, Ruian City, Zhejiang Province, China. Prepayment of RMB 42.54 million (approximately $6.43 million) was made during the year ended December 31, 2018. During the six months ended June 30, 2019, the Company paid additional amount of RMB 2.04 million (approximately $296,000). The total payments of RMB 44.58 million (approximately $6.48 million) was included in prepayment, non-current as of June 30, 2019 on the accompanying consolidated balance sheets. The title to the land use rights was transferred to the Company in July 2019.

Amortization expenses were $347,083 and $301,556 for the six months ended June 30, 2019 and 2018, respectively.

Deferred taxation is calculated under the liability method in respect of taxation effect arising from all timing differences, which are expected with reasonable probability to realize in the foreseeable future. The Company’s subsidiary registered in the PRC is subject to income taxes within the PRC at the applicable tax rate.

The Company obtained those short term loans from Bank of China, Bank of Ningbo, Agricultural Bank of China, China Minsheng, Industrial Bank and China Construction Bank to finance general working capital as well as new equipment acquisition. Interest rate for the loans outstanding during the three months ended June 30, 2019 ranged from 1.35% to 5.44% per annum. The maturity dates of the loans existing as of June 30, 2019 ranged from July 25, 2019 to June 27, 2020. The interest expenses for short term bank loans, including discount fees, were $2,733,192 and $2,590,729 for the three months ended June 30, 2019 and 2018, respectively. The interest expenses for short term bank loans, including discount fees, were $6,168,608 and $4,885,057 for the six months ended June 30, 2019 and 2018, respectively.

As of June 30, 2019, corporate or personal guarantees provided for those bank loans were as follows: 

In November 2017, the Company entered into two identical but independent loan agreements with Far Eastern Horizon Co., Ltd. (“Far Eastern”), each for a term of 36 months and with an effective interest rate of 8.38% per annum, payable monthly in arrears. The total long term obligations under the two agreements amounted to RMB 200,000,000 (approximately $30,608,185), pledged by the Company’s equipment in the original cost of RMB 205,690,574 (approximately $31,479,075). The Company paid debt issuance costs in cash of RMB 5,000,000 (approximately $742,324). The repayments of principal totaled $4,941,721 and $5,083,153 for the six months ended June 30, 2019 and 2018, respectively.  

In November 2017, the Company entered into four independent loan agreements with COSCO Shipping Leasing Co., Ltd. (“COSCO”) for a term of 36 months each. Two of the agreements were signed on November 30, 2017 with an effective interest rate of 8.50% per annum, payable monthly in arrears. The other two agreements were entered into on November 15, 2017, with an effective interest rate of 4.31% per annum, payable monthly in arrears. The total long term obligations under the four agreements amounted to RMB 235,000,000 (approximately $35,964,617), pledged by the Company’s equipment in the original cost of RMB 238,333,639 (approximately $36,474,800). The Company paid debt issuance costs in cash of RMB7,320,000 (approximately $1,025,248). The repayments of principal totaled $6,137,259 and $7,717,633 for the six months ended June 30, 2019 and 2018, respectively. 

The interest expenses for long term loans, including the amortization of debt issuance costs, were $976,937 and $1,998,070 for the six months ended June 30, 2019 and 2018, respectively.

NOTE L - REVENUES FROM CONTRACTS WITH CUSTOMERS

In accordance with ASC 606, the Company disaggregates revenue from contracts with customers by product type. See Note P for information regarding revenue disaggregation by product type.

Deferred revenue is recorded when consideration is received from a customer prior to transferring goods to the customer under the terms of a sales contract. As of June 30, 2019 and December 31, 2018, the Company recorded a deferred revenue liability of $60,023,972 and $51,529,795, respectively, which was presented as “Deposits received from customers” on the accompanying consolidated balance sheets. During six months ended June 30, 2019, the Company recognized $17,587,688 of deferred revenue included in the opening balance of deposits received from customers. The amount was included in sales on the accompanying consolidated statement of income and comprehensive income.

NOTE M - INCOME TAXES

During the year ended December 31, 2018, the Company recognized a one-time transition tax of $11,022,985 that represented management’s estimate of the amount of U.S. corporate income tax based on the deemed repatriation to the United States of the Company’s share of previously deferred earnings of certain non-U.S. subsidiaries of the Company mandated by the U.S. Tax Reform. The Company also recognized related interest and penalty of $587,821 in the year ended December 31, 2018. The Company recognized additional interest and penalty of $107,415 in the six months ended June 30, 2019. The Company elected to pay the one-time transition tax over eight years commencing in 2018. The first installment payment of $881,839 was made during the six months ended June 30, 2019. The actual impact of the U.S. Tax Reform on the Company may differ from management’s estimates, and management may update its judgments based on future regulations or guidance issued or changes in the interpretations taken that would adjust the provisional amounts recorded. As of June 30, 2019, $2,558,913 was included in income tax payable as a current liability which the Company believes will be paid within one year and the remaining balance was included in income tax payable, non-current.

The 2017 Tax Act also created a new requirement that, for the periods beginning after January 1, 2018, certain income (referred to as global intangible low-taxed income or “GILTI”) earned by foreign subsidiaries in excess of a deemed return on tangible assets of foreign corporations must be included in U.S. taxable income. The Company elected to account for GILTI tax in the period the tax is incurred, and therefore included it in estimating the annual effective tax rate.

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

In 2018, the Joint Venture was awarded the Chinese government’s “High-Tech Enterprise” designation for a fourth time, which is valid for three years and it continues to be taxed at the 15% tax rate in 2018, 2019 and 2020.

The reconciliation of the effective income tax rate of the Company to the statutory income tax rate in the PRC for the six months ended June 30, 2019 and 2018 is as follows:

Income taxes are calculated on a separate entity basis. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The provisions for income taxes for the six months ended June 30, 2019 and 2018 are summarized as follows:

NOTE N - OPERATING LEASE

The Company entered into various operating lease agreements for certain of its staff dormitories including a lease agreement with its related party.

In December 2006, Ruian entered into a lease agreement with Ruili Group Co., Ltd., a related party, for the lease of two apartment buildings for Ruian’s management personnel and staff. The initial lease term was from January 2013 to December 2016. This lease was amended in 2013, with a new lease term from January 1, 2013 to December 31, 2022. The annual lease expense is RMB 2,100,000 (approximately $305,980).

Balance sheet information related to operating leases is as follows:

For the six months ended June 30, 2019, the Company had operating lease costs of $288,113 and the reduction in operating lease right of use assets was $253,380. Cash paid for amounts included in the measurement of operating lease liabilities was $689,299 during the six months ended June 30, 2019. 

The weighted-average remaining lease term and the weighted-average discount rate of our leases are as follows:

The following table summarizes the maturity of our operating lease liabilities as of June 30, 2019:

NOTE O - WARRANTY CLAIMS

Warranty claims were $7,063,122 and $1,828,168 for the six months ended June 30, 2019 and 2018, respectively. Warranty claims are included in selling and distribution expenses on the accompanying consolidated statements of income and comprehensive income (loss). Accrued warranty expenses are included in the balances of accrued expenses on the accompanying consolidated balance sheets. The movement of accrued warranty expenses for the six months ended June 30, 2019 was as follows:

NOTE P - SEGMENT INFORMATION

The Company produces brake systems and other related components for different types of commercial vehicles (“Commercial Vehicles Brake Systems”). On August 31, 2010, the Company through Ruian, executed an Asset Purchase Agreement to acquire a segment of the passenger vehicles auto parts business (“Passenger Vehicles Auto Parts”, formerly known as “Passenger Vehicles Brake System”) of Ruili Group. As a result of this acquisition, the Company’s product offerings were expanded to both commercial and passenger vehicles’ brake systems and other key safety-related auto parts.

The Company has two operating segments: Commercial Vehicle Brake Systems and Passenger Vehicles Auto Parts.

For the reporting periods, all of the Company’s long-lived assets are located in the PRC. The Company and its subsidiaries do not have long-lived assets in the United States for the reporting periods.

NOTE Q - CONTINGENCIES